Financial Institutions and Financial Markets

FIN/370

Financial Institutions and Financial Markets

The state of the economy in the United States is very crucial to businesses and society. The success of the economy is reliant on financial institutions and financial markets. “The market for the creation and exchange of financial assets such as money, stocks, and bonds, plays a central role in organizing and coordinating our economy” (Colander, 2013, p. 643). Financial institutions are essential in providing funding for activities that take place within the financial markets. This paper will describe the roles of financial institutions and financial markets in our economy, as well as compare and discuss the differentiations between markets.
The Roles of Financial Institutions Financial institutions play a vital role in the success of our economy and financial markets. They are responsible for financial transactions such as deposits, investments, and loans. Examples of financial institutions are commercial banks, investment banks, credit unions, insurance companies, mutual funds, and brokerages. A few of the well-known U.S. financial institutions are Bank of America, JP Morgan Chase Bank, Wachovia Bank, and Wells Fargo Bank. Financial institutions provide a means of savings for society and businesses. Saving money incurs interest, which allows people and businesses to save additional funds. Financial institutions provide loans so businesses can grow more without sole reliance on their own funds. Without loans and the ability to earn interest on savings, the economy would suffer due to society having less demand for products and services, which could affect employment. Financial institutions provide people with one central location for their money which in return allows these institutions to help others. Financial institutions make money from their members’ deposits and savings. Making money this way allow financial institutions to be able to loan additional funds to the others creating a circle of lending and earning money.
The Roles of Financial Markets “Financial markets exist to manage the flow of funds from investors to borrowers as well as from one investor to another” (Cornett, Adair, & Nofsinger, 2016, p. 131). Financial markets provide the exchange of stocks, derivatives, and commodities. These exchanges provide capital for individuals, companies, and even the government to finance projects and other activities. Financial markets play a major role in the moving and creation of capital within an economy. The economy could experience difficulties without a financial market which would impact the necessary funding of business activities which provides jobs and wages for the members of society. The most well-known financial market is the stock market. When a buyer purchases stock, this means they become part owner of a company as they now own a claim on the company. “Derivatives are a security formalizing an agreement between two parties to exchange a standard quantity of an asset at a predetermined price on a specified date in the future” (Cornett, Adair, & Nofsinger, 2016, p. 137). Commodities are goods that are exchanged for other goods. Financial markets are responsible for funding by channeling funds between suppliers and demanders of funds. Financial markets are categorized into two markets, primary and secondary markets.
Primary and Secondary Markets Primary markets are made up of investments banks that manage transactions for businesses and government agencies. “Primary markets provide a forum in which demanders of funds raise funds by issuing new financial instruments, such as stocks and bonds” (Cornett, Adair, & Nofsinger, 2016, p. 130). The sale of securities begins in the primary market. The sales of securities provide companies or the government the ability to collect funds for activities such as projects and expansions. Investment bankers work as the go-between for the companies selling and those that are buying, typically large investors. Companies selling bonds or stocks for the first time do so on the primary market. Typically this behavior happens through public offerings which are an IPO. Once companies issue their assets, the assets are the sold in secondary markets. Secondary markets are where the securities sold through the primary market, are traded. Examples of such secondary markets are the New York Stock Exchange and NASDAQ. “The secondary market delivers liquidity to shareholders through a controlled environment that enforces specified transaction parameters” (“Secondmarket”, 2016). Brokers purchase securities on behalf of the investor in these markets. Secondary markets are used for the trade of existing securities while primary markets are used for the issuance of new securities.
Money and Capital Markets Financial markets are differentiated in part by the maturity dates of the instruments traded, which is important in understanding the difference between money and capital markets (Cornett, Adair, & Nofsinger, 2016, p.132). Money markets instruments are debt securities such as treasury bills, repurchase agreements, or commercial paper that mature in a year or less. Money market securities are less risky because they are short-term, unlike long-term instruments. Unlike secondary markets, money market trades can occur by telephone or online trading. Money market instruments are most used by individuals investing money to increase the value of the money and access the new balance in a shorter time span. Most money market instruments are used for temporary cash storage, and earn returns with relatively low-interest rates. Capital markets are the trading of stocks and bonds that mature within one year. Unlike the money markets where price fluctuations are minimal, capital markets are most susceptible to more price fluctuations. Capital markets provide long-term maturities allowing companies to raise the necessary capital, as well as provide individuals with more time to pay back loans. Examples of capital market instruments are U.S. Treasury notes and bonds, the federal government and state government bonds, and corporate bonds and stocks. Mortgage loans for homes and businesses are the most common capital market instruments.
Conclusion
Financial institutions and markets are organizations that facilitate the flow of capital between investors and companies (Cornett, Adair, & Nofsinger, 2016, p.7). The U.S. economy is essential to the success of our country. In order to remain successful, the instruments provided by financial institutions and financial markets are vital to our survival. Financial institutions provide instruments that allow us to save money and earn interest, provide loans to purchase homes, cars, and other necessities. Financial markets provide opportunities for companies and individuals to buy and sell securities that help promote the economy. Each market is unique in providing money solutions to benefit the common good. Strong financial markets are attributed to growing an economy.
References
Colander, D. C. (2013). Economics (9th ed.). Retrieved from The University of Phoenix eBook Collection database.
Cornett, M., Adair, T., & Nofsinger, J. (2016). Finance (3rd ed.). Retrieved from The University of Phoenix eBook Collection.
SecondMarket. (2016). Retrieved from https://www.secondmarket.com/