Financial system Essay Example | Topics and Well Written Essays - 2750 words

Financial system - Essay Example Financial instruments are paper documents. Yet just as a surgeon uses instruments as financial instruments to undertake crucial exchanges of financial resources. They also can use financial instruments to help reduce the risks of financial loss. There are two basic ways to categorise financial markets. One, which distinguishes between primary or secondary markets, separates types of financial markets depending upon whether or not they are markets for newly issued instruments. The other, which distinguishes between capital and money markets, defines financial markets on the basis of the instrument maturities. The maturity of an instrument is the time ranging from the date of issue until final principal and interest payments are due to the holders of the instruments. Maturities of less than a year are short-term maturities, while maturities in excess of ten years are long-term maturities. Maturities ranging from one to ten years are intermediate-term maturities. Institutions that serve as the middlemen in this process of financing are financial intermediaries. These intermediaries exist solely to take the funds of savers and redistribute those funds to the ultimate borrowers. When individual savers allocate some of their saving to a business by purchasing a corporate bond, they effectively make a direct loan to the business. That is, they assist in the direct finance of the capital investment that the business desires to undertake. But the process of financing such endeavours is not always so direct. Consider, for instance, what may happen if the server also purchases a long-term time deposit issue by a banking firm. The bank, turn, may use these funds, together with those of other deposit holders to buy corporate bonds issued by the same business. In this instance, the saver has indirectly financed business capital investment. The bank, in turn, has intermediated the financing of the investment. There are two types of finance Direct finance Indirect finance In the case of direct finance, a financial intermediary such as a bank plays no role. A saver lends directly to parties who undertake investment. Under indirect finance, however, some other institution channels the funds of savers to those who wish to make capital investments. This latter process of indirect finance, which is the most common way in which funds are channelled from saving to investment, is financial intermediation. There are two groups, which comprise market: 1) Involved: These are the people who are the market participants of economic theory. They have all the knowledge regarding financial assets portfolio. 2) Uninvolved: these are the people with limited knowledge. The usually don't have information about the nature of financial claims and fair market value. The financial intermediaries help these people by providing services in shape of information. By investing on their behalf. This reduced the perceived cost of transaction due to the lack of information. Most of the household consumers partly participate in the market. (Allen & Santomero, 1998). Benefits of