2. Notion, functions, types of financial intermediaries. Financial intermediaries in Russia.

Financial intermediaries are financial institutions and entities which mediate between market participants and financial markets. Institutions such as banks, mutual funds and securities dealers and mortgage firms are examples of financial intermediaries.

Financial intermediaries exist in order to allocate and channel capital more efficiently. They perform 6 functions in the economy:

1. Asset Transformation, which consists of Diversification, Evaluation and Repackaging.

Diversification is spreading the investment over several stocks to reduce unsystematic risk of an asset. By unsystematic risk we understand the risk which is attributed only to the concrete stock. Systematic risk, which is the risk of the economy as a whole cannot be reduced.

Since you need to diversify your investment you need to buy the stocks of several firms. You may not have sufficient funds to buy the stocks of many firms. Financial intermediaries like mutual funds provide this service. They sell shares of the mutual fund to small investors and use the money collected to buy the stocks of a large number of firms. Because you own shares of the mutual fund you indirectly derive the benefit of diversification.

Evaluation is the service of expertise and research of stocks provided by intermediaries in order to help investors decide and compensate their lack of expertise and time to research assets.

Finally borrowers may want funds in different quantities. For example a firm may want $100 million it is extremely difficult to find someone willing to lend that much of money. But if small amounts can be gathered from a large number of investors, then is becomes much easier to raise capital. The borrowing firm usually does not have the information necessary to gather such small deposits, therefore financial intermediaries like banks and mutual funds, pension funds step in and provide the capital which they collected in small amounts from individual investors. Therefore the financial intermediaries have repackaged several small amounts into a big lump sum amount.

2. Production of a medium of exchange. Financial intermediaries create new securities that act as a new asset which serves as a medium of exchange between lenders and borrowers.

3. Act as a conduit between lenders and borrowers.

4. Reduction of Information Asymmetry: Lenders face additional risk as they do not know the whole information about the borrower. Therefore, lenders try to gather as much information on the borrower’s business as possible. So there is a market for information; financial intermediaries exploit this opportunity by producing (or discovering through research) necessary information. Besides this if each investor individually researched the same firm, they are all duplicating their efforts and costs increase. Borrowers, from their side, do not want their secret information about their businesses which will be disclosed if the borrower goes to the public capital markets. So they are eager to address financial intermediaries which will save their information from disclosure.

Therefore financial intermediaries reduce Asymmetry of information by gathering and selling it to private investors and at the same time protect the leakage of proprietary information of firms.

5. Reduction of Agency Costs: Financial Intermediary may take the responsibility over monitoring of the processes inside the company and controlling of agency costs, which may be caused by the conflict of interest between shareholders and the managers. As managers should improve shareholders’ wealth but tend to improve their own welfare, by using advantages of their positions, such as private jets, etc. as they spend shareholders’ money.

Therefore, if the intermediary takes the monitoring over the managerial situation in its hands, it reduces Agency costs of monitoring of the company be the shareholders themselves as they may not want to take the responsibility of controlling the common money and benefit from free-riding on other shareholders.

6. Reduction of Transaction Costs: As investors have to rebalance their portfolio to minimize risks and maximize profits, they will face a lot of transactions to make and each of them would incur commissions and other transaction costs. Therefore, if investors would confide their portfolios to intermediaries, they will benefit on economies of scale, as intermediaries save money on large number of transactions and amounts transmitted.

Financial Intermediaries in Russia

Список видов деятельности в бизнес-справочнике прочего финансового посредничества России

Финансовый лизинг,,Предоставление кредита,,Предоставление потребительского кредита,,Предоставление займов промышленности,,Предоставление денежных ссуд под залог недвижимого имущества,,Предоставление кредитов на покупку домов специализированными учреждениями, не принимающими депозиты,,Предоставление услуг по обеспечению кредитных карточек,,Предоставление ломбардами краткосрочных кредитов под залог движимого имущества,,Финансовое посредничество, не включенное в другие группировки,,Капиталовложения в ценные бумаги,,Деятельность дилеров,,Капиталовложения в собственность,,Заключение свопов, опционов и других биржевых сделок,,Деятельность холдинг-компаний в области финансового посредничества,

3. Money and capital markets: functions, instruments, indicators.

Money market is the Market for short-term financial instruments with maturity less than one year.

Money market enables participants to borrow or lend liquid assets and therefore meet needs for cash or investment of cash.

Functions of money market

The most important function of a money market is to provide a means whereby economic units

can quickly adjust through cash positions. For all economic units (business, households financial

institutions or governments) the timing of cash inflows is rarely perfectly synchronized or

predictable in the short run.

However, buffer stocks of cash ties up resources in a relatively improfitable form. Thus, if a unit

has access to facilities for short-term lending and borrowing at low transaction costs, then, given

the same general pattern of cash inflows and outflows, it can operate with a lower average stock

of cash. Organized money markets provide obvious advantages to many units such as banks and

large companies who deal in large sums.

In addition to facilitating the liquidity management of economic actors, money markets fulfil a

number of additional economic functions:

1. Interest rates on money market instruments serve as reference rates for pricing all debt

instruments;

2. Governments or central banks use money market instruments as tools at monetary policy;

3. Short-term interbank markets, finance longer-term lending when financial intermediaries

transform maturities.

The participants of the money market are:

• the treasury,

• government securities dealers,

• commercial banks,

• non-financial corporations.

Money-market instruments:

• Treasury bills

• Federal funds – funds that are immediately available for lending and borrowing among financial institutions.

• Repurchase agreements – agreement between a buyer and a seller to in a sale of a security to reserve the transaction in the future at a specified date and price.

• Negotiable certificates of deposits – financial instrument issued by a bank documenting a deposit, with principle and interest repayable to a bearer at a specified future date.

• Commercial papers – unsecured promissory note, issued by corporations, with an original maturity of 270 days and less.

• Banker’s acceptances

Money market instruments possess qualities which make them useful for wholesale trade:

Liquidity – the ability of the asset to be converted into cash relatively easy and without significant loss in price in the process

Default risk – the risk of non-payment of the principle or interest – it should be minimal for an asset to be considered an investment opportunity for liquidity excess.

Capital market is a market for relatively long-term (with maturity over 1 year) financial instruments, such as bonds and stocks.

Inside both markets there is a primary market – for newly issued securities and secondary market – for already existing ones.

Functions of capital markets

Corporations secure their financing through capital markets by selling long-term claims on their firms, whether in the form of bonds (liabilities) or stock (equity). Governments go to capital markets for operating funds and capital projects. Households use them mainly for residential mortgage financing.

When referring to a capital market, it is important to note that the term can refer to a rather broad range of products and services that are associated with finances and investments. To that end, a capital market will include such components as the stock market, commodities exchanges, the bond market, and just about any physical or virtual facility or medium where debt and equity securities can be bought or sold.

As a market for securities with a very broad reach, the capital market is an ideal environment for the creation of strategies that can result in raising long-term funds for bond issues or even mortgages.

Participants of the capital markets

Institutions are a part of the framework of the capital market along with the corporations. Stock exchanges are one of the more visible examples of established operations that give form and function to the capital market. Along with the stock exchanges, support organizations such as brokerage firms also form part of the capital market. Over the counter markets are also included in the working definition for a capital market. By providing the mechanisms that make trading possible, these outward expressions of the capital market make it possible to keep the process ethical and more easily governed according to local laws and customs.

Because of the broad structure of the capital market, investors of all types have the opportunity to participate in financial strategies that can strengthen the general economy as well create financial security. Persons who wish to focus on investment opportunities that are very stable and more or less ensure a modest return can find plenty of different offerings to choose from. At the same time, investors who tend to be more adventurous can also find a wide array of investment types that will allow them to take some additional risk and possibly realize larger returns on their investments. While the overall structure of the capital market may be broad, there are a number of checks and balances that help to keep the market on an even keel, ensuring that the capital market functions in a manner that is both ethical and legal.

Capital-market instruments:

• Government notes and bonds

• Municipal binds

• Corporate bonds

• Corporate stocks

• Mortgages