Role of Financial Intermediaries Ι About the Secondary Markets.
Introduction of secondary markets
When the original purchasers of securities sell their securities, they trade in secondary markets. These securities may subsequently trade repeatedly in the secondary market, but the original issuers will be unaffected in the sense that they receive no additional cash from these transactions. In the secondary markets, the seller of the securities receives the proceeds, not the issuer.
Introduction to financial intermediaries
Financial intermediaries channel the savings of individuals, businesses, and governments into loans or investments. The key suppliers and demanders of funds are individuals, businesses, and governments.
In general, individuals are net suppliers of funds, while businesses and governments are net demanders of funds. The major intermediaries are commercial banks, mutual funds, life insurance companies, and finance companies.
Role of financial intermediaries
Financial institutions such as banks and insurance companies are important sources of financing for businesses. They enable the flow of capital from the people and institutions to the businesses and individuals who need financing.
Financial institutions provide a payment mechanism for the economy and offer risk pooling, loans and deposits, and other services to their customers.
1) Financial intermediaries take in the savings of investors and convert them into stocks and bonds. The money generated from stocks and bonds is finally used by firms to make investments.
The investors cannot themselves do that because there is an informational asymmetry between the investors and the firms. The financial intermediaries reduce the search, collection and processing cost of investors.
2) Financial intermediaries allow individual small savers to access large investment projects through the mechanism of fund pooling.
Individual investors are usually too small to benefit individually from large projects. Pooling done by financial intermediaries allows small investors to access this avenue.
3) Financial intermediaries help diversify risk for small investors. Large projects carry large risks. It is difficult for small investors to invest in large risky investment projects by themselves.
Financial intermediaries allow them to pool risks. They can form portfolios of large risky investments.
4) Long-term projects require long-term investment. Most small investors cannot afford to invest in the long term. They want to invest in the short term. This temporal gap is bridged by financial intermediation. This process is called liquidity management.
Once again, long-term projects have a higher return than ordinary investors cannot access, as they only have short-term investment options. Financial intermediaries make this possible.