1. Financial Intermediaries
Financial intermediaries are institutions that act as middlemen between savers and borrowers, facilitating the flow of funds in the economy. They play a crucial role in channeling savings into investments, thereby contributing to economic growth. Examples include banks, credit unions, insurance companies, pension funds, and investment funds. Their primary function is to reduce risk, improve liquidity, and provide access to capital for individuals and businesses.
Key exam points:
- Types of Financial Intermediaries: Commercial banks, investment banks, insurance companies, pension funds, etc.
- Role of Financial Intermediaries: They reduce transaction costs, manage risks through diversification, and provide liquidity.
- Transforming Maturity and Risk: Converting short-term deposits into long-term loans while reducing the risk through diversification.
2. Financial Markets
Financial markets are platforms where financial instruments, such as stocks, bonds, and derivatives, are bought and sold. These markets enable the transfer of capital between investors, businesses, and governments, ensuring that funds are allocated efficiently. Financial markets can be categorized into capital markets (for long-term funding) and money markets (for short-term liquidity).
Key exam points:
- Types of Financial Markets: Capital markets (stocks and bonds), money markets (short-term debt instruments), and derivatives markets.
- Primary and Secondary Markets: Primary markets involve new issues of securities (e.g., Initial Public Offerings), while secondary markets involve trading existing securities.
- Role in the Economy: Financial markets facilitate price discovery, liquidity provision, and risk transfer.
3. International Money and Capital Markets
International money and capital markets refer to global platforms where financial assets, such as currencies, bonds, and stocks, are traded. These markets allow countries and corporations to raise funds, manage foreign exchange risks, and invest across borders. Key institutions include global stock exchanges, international banks, and currency markets. International markets help allocate capital globally, improve liquidity, and facilitate international trade.
Key exam points:
- Money Market: Short-term borrowing and lending, primarily in foreign currencies, with instruments such as treasury bills and commercial paper.
- Capital Market: Long-term financial instruments, such as international bonds and equities.
- Globalization of Finance: How capital moves across borders, enabling businesses to access international funding.
4. Rates of Interest and Rates of Return
Interest rates represent the cost of borrowing or the return on investment for lending money. Rates of return, on the other hand, refer to the profit earned on investments relative to their cost. These rates are essential for financial decision-making, influencing savings, investments, and capital allocation.
Key exam points:
- Nominal vs. Real Interest Rates: Nominal rates do not account for inflation, while real interest rates do.
- Determinants of Interest Rates: Central bank policies, inflation expectations, and risk premium.
- Risk and Return Relationship: Higher returns typically come with higher risks (e.g., stock market returns vs. government bonds).
5. Money Market Instruments
Money market instruments are short-term financial instruments typically used by governments, financial institutions, and large corporations to manage their short-term liquidity needs. These instruments are highly liquid and generally low-risk. Examples include Treasury bills, certificates of deposit (CDs), commercial paper, and repurchase agreements (repos).
Key exam points:
- Treasury Bills (T-bills): Short-term debt issued by governments with maturities of less than one year.
- Commercial Paper: Unsecured, short-term debt issued by corporations to finance their working capital needs.
- Certificates of Deposit (CDs): Time deposits with banks that pay interest for a fixed term.
- Repos: Short-term borrowing agreements where securities are sold and later repurchased at a higher price.
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