M and B
Quiz 1 :
The Financial System and the Economy
Equity Security is a contract where the security holder becomes the owner of the company that issued the Security. Equity Security is also known as Stock. The Equity Security or Shareholder is entitled to dividends from post-tax earnings, which are taxed at a lower rate. Example of an Equity Securities is common Stock Shares. Debt Securities is a contract where the Security holder is entitled to a fixed rate of interest as specified in the agreements, it consists a legal obligation to repay borrowed funds at a specified maturity date. The Example of Debt Securities includes Commercial Papers, Bonds, Loans (Short or Long Term), debentures, and T-Bills etc. The Debt Securities Holders receive interest, which are tax-deductible and company can save it and pay less tax. Issue of Debt Securities helps the company from losing control over itself operations. This also increases the probability of bankruptcy. The main features that distinguish Equity from Debt Securities are: From the economical surveys and position of international market it can be confer that debt is more over equity outstanding in the United States. Since, up to 70% of overall securities are Debt Securities and in the remaining, comes the Equity Securities. It is generally invested in Debt mostly since fixed rate of interest can be earned periodically and even the principal amount is repaid on the maturity date, and in view of the company, it allows or issues debt security since it helps the company to pay less tax.
Financial Intermediaries are the medium or middle-men for Issuers and Savers for exchange of their funds. Financial Intermediaries are the core participants in the financial system since it holds a large ratio of all the securities. The various forms of Financial Intermediaries are Stock Exchange, Investment Bankers, Underwriters, Registrars, Depositories, Custodians, Forex Dealers, Mutual Funds, Pension Funds, Life Insurance companies etc. The main roles that Financial Intermediaries plays in Financial System are: • It brings both the Issuers and Savers to one platform and provides funds for the needy and banker for the other. • It ensure transfer of funds from the lender to the borrower i.e., it provides the funds to the one who is in need of it and helps the savers to invest their surplus funds. • It ensures diversified investments for the savers, which consoles the savers and relives from the threat of highly riskiness. Example: If Mr. Cris invests $10,000 in XYZ Ltd., company alone it will be a too risky since the entire surplus has been invested in one, and if $10,000 has been invested in two or more forms of securities in different companies then Mr. Cris can hedge himself and manage his funds. • It pools all the surplus funds of many savers and lends to the needy or borrowers. This pooling of funds by Financial Intermediaries helps the borrowers to find the large amount of investor. • It generally inculcates short-term deposits from the savers and funds long-term loans for the borrowers. Since, lenders/savers intend to earn returns frequently; but the borrowers need the funds for carrying on its activities as per the requirement for long-term period. • It helps in highly safeguarding of the funds of the savers and collecting it back promptly from the borrowers. • It even helps in reduction of costs of transacting, i.e. underwriting, credit rating potentiality of the borrowers; it even helps in specialized analyzation of the borrower potentiality.
Direct Finance: When the savers or lenders lends or buys securities directly from borrowers or issuers, it is said to be direct finance. Indirect Finance: When savers or lenders of funds invest through financial intermediaries, to issuers or borrowers it is said to be indirect finance. A Financial Intermediary is the institution which is engaged in supply of funds to the borrowers whenever need from taking and pooling it from the savers or issuers. When Direct Finance and Indirect Finance is compared it has seen that Indirect Finance is vital very larger in number than compared with Direct Finance. Both Direct and Indirect Finance use financial securities, and its transactions are conducted in financial markets. In case of young financial system, it generally relies more on intermediaries, so indirect finance is more than direct finance in young financial system. The young economy indirect finance is more because at the time of initial stages a company can issue shares or bonds directly and earn but whereas in between medieval for expansion an all the scare funds can be easily bought from intermediaries therefore, in young economy indirect finance is comparatively in larger ratio.