With an understanding of what financial assets are and the role of financial assets and financial markets, we can now identify who the players are in the financial markets. By this we mean the entities that issue financial assets and the entities that invest in financial assets. We will focus on one particular group of market players, called financial intermediaries, because of the key economic functions that they perform in financial markets. In addition to reviewing their economic function, we will set forth the basic asset/liability problem faced by managers of financial intermediaries.
There are entities that issue financial assets, both debt instruments and equity instruments. There are investors who purchase these financial assets. This does not mean that these two groups are mutually exclusive—it is common for an entity to both issue a financial asset and at the same time invest in a different financial asset.
A simple classification of these entities is as follows: (1) central governments; (2) agencies of central governments; (3) municipal governments; (4) supranationals; (5) nonfinancial businesses; (6) financial enterprises; and (7) households. Central governments borrow funds for a wide variety of reasons. Many central governments establish agencies to raise funds to perform specific functions. Most countries have municipalities or provinces that raise funds in the capital market. A supranational institution is an organization that is formed by two or more central governments through international treaties. Businesses are classified into nonfinancial and financial businesses. These entities borrow funds in the debt market and raise funds in the equity market. Nonfinancial businesses are divided into three categories: corporations, farms, and nonfarm/noncorporate businesses. The first category includes corporations that manufacture products (e.g., cars, steel, computers) and/or provide nonfinancial services (e.g., transportation, utilities, computer programming). In the last category are businesses that produce the same products or provide the same services but are not incorporated.
Financial businesses, more popularly referred to as financial institutions, provide services related to one or more of the following:
1. Transforming financial assets acquired through the market and constituting them into a different and more preferable type of asset—which becomes their liability. This is the function performed by financial intermediaries, the most important type of financial institution.
2. Exchanging financial assets on behalf of customers. 3. Exchanging financial assets for their own account. 4. Assisting in the creation of financial assets for their customers and then
selling those financial assets to other market participants. 5. Providing investment advice to other market participants. 6. Managing the portfolios of other market participants.
Financial intermediaries include: depository institutions that acquire the bulk of their funds by offering their liabilities to the public mostly in the form of deposits; insurance companies (life and property and casualty companies); pension funds; and finance companies. The second and third services in the list above are the broker and dealer functions. The fourth service is referred to as securities underwriting. Typically, a financial institution that provides an underwriting service also provides a broker- age and/or dealer service.
Some nonfinancial businesses have subsidiaries that provide financial services. For example, many large manufacturing firms have subsidiaries that provide financing for the parent company’s customer. These financial institutions are called captive finance companies.
Posts Tagged ‘financial assets’
OVERVIEW OF MARKET PARTICIPANTS
Tuesday, September 14th, 2010Secondary Markets
Thursday, July 15th, 2010The secondary market is where already-issued financial assets are traded. The key distinction between a primary market and a secondary market is that in the secondary market the issuer of the asset does not receive funds from the buyer. Rather, the existing issue changes hands in the secondary market, and funds flow from the buyer of the asset to the seller. Below we explain the various features of secondary markets. These features are common to any type of financial instrument traded.
It is in the secondary market where an issuer of securities, whether the issuer is a corporation or a governmental unit, may be provided with regular information about the value of the security. The periodic trading of the asset reveals to the issuer the consensus price that the asset commands in an open market. Thus, firms can discover what value investors attach to their stocks, and firms and noncorporate issuers can observe the prices of their bonds and the implied interest rates investors expect and demand from them. Such information helps issuers assess how well they are using the funds acquired from earlier primary market activities, and it also indicates how receptive investors would be to new offerings.
The other service a secondary market offers issuers is that it provides the opportunity for the original buyers of the asset to reverse their investment by selling it for cash. Unless investors are confident that they can shift from one financial asset to another as they may deem necessary, they would naturally be reluctant to buy any financial asset. Such reluctance would harm potential issuers in one of two ways: either issuers would be unable to sell new securities at all or they would have to pay a high rate of return, as investors would demand greater compensation for the expected illiquidity of the securities.
Investors in financial assets receive several benefits from a secondary market. Such a market obviously offers them liquidity for their assets as well as information about the assets’ fair or consensus values. Further, secondary markets bring together many interested parties and so can reduce the costs of searching for likely buyers and sellers of assets. Moreover, by accommodating many trades, secondary markets keep the cost of transactions low. By keeping the costs of both searching and transacting low, secondary markets encourage investors to purchase financial assets.