Primary Elements and Functions of a Modern Financial System - Assignment Example

Introductory Finance Students Name: Institutions Name: Instructors Name; Course Code: Date of Submission: Introduction Financial system is a way in which money is transferred between the investors and the borrowers. It works in global market or domestic market so that the investors can obtain finance to fund their investment projects (Viney, 2007). This system is effective in allocating resources in modern economy by channeling family savings to corporate sector and distributes finances to different firms and also improves sharing of household and organizations risks (Elton & Gruber, 2003). Financial system has two elements namely financial intermediaries and financial markets. They are responsible for transferring funds from savers to investors. Question 1 Primary elements and functions of a modern financial system The relationship between liquidity and production capacity of the economy occur because most investment projects with high returns require long term sources of finance but lenders who are risk averse are not able to share their control function to investors for long payback periods (Shapiro, 2006). It is therefore the function of financial system to activate savings through agglomeration and gathering financial resources from different sources and forming a small point in which these resources are allocated. These points are called financial instruments and they are responsible for providing opportunities for investors to own diversified portfolios. Financial intermediaries also increase risk sharing between different investors which enhance liquidity (Ross, 2007). Without intermediaries such as financial institutions, investors are held in permanent illiquid investments that are able to produce high investment returns to investors who remain in the business the end of the investment (Elton & Gruber, 2003). Investors who are entitled to early payoffs receive low returns because in the early hours consumption needs premature liquidation of permanent investments. Financial market also has the ability to change illiquid assets into liquid assets (Marc & Groz, 2009). The availability of financial markets, investors are able to own assets in the form of equity or bonds which can be changed easily into purchasing power if there is need to access savings. Financial systems are also able to provide different sources of finance to various borrowers in modern economy (Viney, 2007). They provide it in the form of debt or equity at lower costs to encourage investments. Function and purpose of both the primary and secondary markets Raise Capital for Businesses There are several functions and purpose of primary and secondary markets in modern economy. These markets are formed to help investors raise money for different business (Ross, 2007). These markets provide different companies with the facility to raise capital for expansion through selling shares to investing public. Mobilize Savings for Investment When different investors draws their savings and buy shares it leads to a more a location of resources in more useful activities hence help to provide commerce and industries in modern economy (Elton & Gruber, 2003). Redistribution of Wealth By giving a wide spectrum of people chance to buy shares therefore becoming part of owners of profitable enterprises (Viney, 2007). It helps in reducing lack of income inequalities since many people get a chance to share profits of the firm which was set up by other people. Improves Corporate Governance By having varied scope of owners, company generally tends to improve on their management standards and efficiency in order to satisfy the demand of the shareholders (Ross, 2007). It is evidence that generally public companies tend to have better management records than private companies. Create investment Opportunities These markets are formed for the purpose of creating investment opportunities for small investors as opposed to other businesses that require large capital outlay (Marc & Groz, 2009). Investing in shares is open to small or large companies since one buys only the number of share they can afford. Types of Financial Instruments There are four types of financial instruments in financial markets. They include equities, mutual funds, bonds, deposits and cash equivalents. Equities There are types of securities which are responsible for allowing investors to be the owners of a given company (Viney, 2007). They provide the voting power of investors which influence their control and influence in the company. These securities are sold in the stock exchange where they are purchased by the general public through IPO (Ross, 2007). The investment in these securities is very important as it provides high investment returns over a long period of time. It also enables the shareholders not to contribute to payment of creditors when the company becomes insolvent Mutual funds This is also a very important financial instrument that allow different group of people to pool their resources together so that they can be managed professionally in accordance with the investment objectives. This instrument is very common as it tends to be cost effective, risk diversification and has professional management of resources. Bonds These are instruments which require the borrower to pay fixed interest. It is provided for the purpose of increasing investment capital for the company. These types of bonds which are provided by the Government have low risk level but can only generate fair returns (Marc & Groz, 2009). They are in the form of debenture and preference shares. Deposits The company can invest in banks or post office deposits to get additional funds to finance other investments. These types of instruments have low risk and have the potential of providing high investment returns to the business organization or investor. Cash equivalents These are securities which can be easily converted into cash (Elton & Gruber, 2003). They are very liquid and they include treasury bills and money markets. Question 2 Advantages and Disadvantages of the Publically Listed Corporate There are several advantages and disadvantages of listing companies in the stock exchange. Advantages Listing in the stock exchange facilitates the issuance of securities to raise new finance to finance its expansion of investment projects. Through this it reduces overdependence on retained earnings and bank loans (Marc & Groz, 2009). It also makes shares to be easily transferable from one shareholder to the next. These investors can trade in shares of the company hence mobilize savings for investment. Listed companies also have the potential of obtaining underwriting facilities like pension food schemes because it has the power to negotiate with strength for good underwriters as its shares are likely to be sold out (Keith, 2010). Listed companies also have the ability to raise permanent source of finance by way of selling securities to the public. This prevents them from borrowing from other financial institutions which require the company to pay interest. Listing also makes companies to operate within some ethical guidelines and this prevents them from engaging in unethical activities and unfair practices. Disadvantages Listing requires high capital outlay and therefore to obtain quotation the company must pay high cost when issuing new shares (Marc & Groz, 2009). There is also loss of secrets to competitors who may be unquoted. This information revealed during listing makes the company to lose important information to competitors which can be used to compete against the company. There is also loss of control of the incoming shareholders who require votes in the company which they may apply to alter the policies of the company (Keith, 2010). All listed companies pay dividend to its owners which is not a tax allowable expense thus compounding the cost of capital. These disadvantages discourage many companies from obtaining quotation. Importance of accurate and timely information flow for stock market efficiency The accurate and timely flow of information in the stock market is important in ensuring that the information received is reflected in the price of shares (Marc & Groz, 2009). This is because any negative information received from the market leads to decline in share prices while positive information leads to increase in share prices. This makes the market to be efficient as it makes the market to have positive market efficiency (Keith, 2010). It is also enable the public to determine the real value of shares as information received affects the price of shares in the market. Roles that ASIC and the ASX play in the Australian stock market ASIC and the ASX has several functions in the Australian stock market. They encourage investors and financial consumers to have trust and confidence in the stock exchange market. They educate and advice investors on the best way of benefiting from the market. They also protect investors from misleading behavior which affects services of the stock market (Keith, 2010). This makes the investors to have confidence in the services of the stock market. They are also responsible for regulating all the companies in Australia, financial markets and other professionals. This is done by providing rules and policies which provide guidelines on how companies in Australia carry out their operations (Elton & Gruber, 2003). They also provide license and control different people and organizations that participate in consumer credit operations. They also ensure that all licensees meet the required standards of being a member of stock exchange (Marc & Groz, 2009). As being the main market regulator, they evaluate the manner in which authorized financial markets operate in accordance with their legal obligations to carry out their business reasonably, systematically and transparently. Conclusion It is important for every corporate company to be listed in the stock exchange. Listing has several importances than disadvantages. Listing enable the company to obtain long term sources of finance at a lower cost since the financial market involves in the sale of shares which the company use to finance its investment projects. It is therefore appropriate for any business organization which intends to go public to understand the benefits and problems which are involves. They must be ready to adhere with quotation regulations which are very demanding. References Elton, M. & Gruber, G. 2003. Modern Portfolio Theory and Investment Analysis, John Wiley & Sons, New York Keith, P. 2010. Finance and Financial Markets, Palgrave ISBN 978-0230233218 Marc M & Groz, V. 2009. Forbes Guide to the Markets, John Wiley & Sons, Inc., New York ISBN 978-0470463383. Ross, S. 2007. Fundamentals of Corporate Finance (4 ed.). Sydney, NSW, Australia: Mcgraw-Hill Irwin Shapiro, Y. 2006. Multinational financial management (8th edn ed.). Hoboken, New Jersey, United States: John Wiley & Sons. Viney, C. 2007. Financial institutions, instruments and markets (5th ed.). North Ryde, NSW, Australia: McGraw-Hill Irwin Australia Pty Ltd. Read More