 |  Money and Capital Markets: Financial Institutions and Instruments in a Global Marketplace, 8/e Peter Rose,
Texas A & M University
Functions and Roles of the Financial System in the Global Economy
Chapter SummaryThe opening chapter of Money and Capital Markets presents us with an introduction to the
global financial system in which the money and capital markets play central roles. It also
highlights the principal institutions that shape the character and functioning of the world’s
financial marketplace. The chapter’s clear emphasis is on the roles and functions performed
by the financial system to make our daily lives better, more enjoyable, and more personally
and professionally rewarding.
- The financial system produces and distributes financial services to the public. Among its
most important services is a supply of credit which allows businesses, households, and
governments to invest and acquire assets they need for daily economic activity. The financial
system of money and capital markets determines both the amount and cost of
credit available. In turn, the supply and cost of credit affect the health and growth of the
global economy and our own economic welfare.
- Credit and other financial services are offered for sale in the institution we call a market.
Markets allocate financial and physical resources that are always scarce relative to
the demand for them.
- Another key role played by markets operating within the financial system is to stimulate
an adequate volume of savings by the public and to transform those savings into an adequate
volume of investment. In turn, investment generates new products and services,
creates new jobs and new businesses, resulting in faster economic growth and a higher
standard of living. By determining interest rates within the financial system the money
and capital markets bring the volume of savings generated by the public into balance
with the volume of investment in new plant and equipment and in inventories of goods
and resources available for sale.
- One important way to view the financial system of money and capital markets is by examining
its seven key functions or roles, which include generating savings, stimulating
the accumulation of wealth, providing liquidity for spending, providing a mechanism
for making payments, supplying credit to aid in the purchase of goods and services, providing
risk protection services, and supplying a channel for government policy in helping
to achieve each of the nation’s economic goals (including full employment, low
inflation, and sustainable economic growth).
- The markets that serve the financial system may be classified in several different ways,
including money markets, supplying short-term loans (credit) of less than a year, and
capital markets, supplying long-term loans (credit), lasting longer than one year. There
are also open markets where anyone may participate as buyer or seller versus negotiated
markets where only a few bidders seek to reach agreement on a financial transaction.
There are primary versus secondary markets; in the former, new financial instruments
are traded in contrast to the latter where existing, rather than new, instruments are exchanged.
Additional types of financial markets that make up the global financial system
include those markets that deal in the immediate purchase or sale of goods or services,
called spot markets, and those that promise future sale and delivery, known as futures,
forward, or option markets.
- While there are many different segments that make up the money and capital markets
around the globe, all of these markets share the common purpose of supplying credit to
answer global demands for borrowed funds and all encourage saving to make investment
(and therefore, economic growth) possible. Funds flow easily and, for the most
part, smoothly from one segment of the financial marketplace to another, spurred by
such forces as arbitrage and speculation. For example, arbitrage causes credit, savings,
and investment to flow toward those areas or market segments that offer the most favorable
returns, helping different markets to price resources more consistently and to
rapidly eliminate price disparities for the same goods and services. Prices are also
brought into better balance from market to market by the force of speculation, which
seeks out underpriced and overpriced services and goods.
- Finally, the money and capital markets have revealed themselves to be highly efficient
institutions, gathering and quickly using all relevant information to price credit and
other financial services. Some are nearly perfect markets where competition sets prices
and allocates resources. However, imperfections do exist within the financial system
where competition is sometimes restricted and excess profits are sometimes earned by
those who stifle competition and gain access to inside information not freely available
to all due to asymmetries within the financial marketplace.
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2003 McGraw-Hill Higher Education