 |  Money and Capital Markets: Financial Institutions and Instruments in a Global Marketplace, 8/e Peter Rose,
Texas A & M University
Financial Assets, Money, Financial Transactions and Financial Institutions
Chapter SummaryThe global financial system of money and capital markets performs the important function
of channeling savings into investment. In that process a unique kind of asset in the economy
—a financial asset—is created.
- Financial assets represent claims against the income and assets of the individuals and
institutions issuing those claims. There are three major categories of financial assets—
money, debt, and equities.Afourth instrument, derivatives, is closely related to financial
assets, deriving its value from these assets.
- Money is among the most important of all financial assets in the economy because it
serves as a medium of exchange to facilitate purchases of goods and services, a standard
for valuing all items bought and sold, a store of value (purchasing power) when needed
in the future, and a reserve of liquidity (immediate spending power). Despite all these
advantages, money has a weakness—susceptibility to inflation or a rising price level,
because its rate of return or yield is normally so low. In contrast, the financial assets represented
by debt or equity securities, and often by derivatives as well, carry greater average
yields but, unlike money, may incur loss when converted into immediately
spendable funds.
- The creation of financial assets occurs within the financial system through three different
channels—direct, semidirect, or indirect finance. Direct finance involves the direct
exchange of financial assets for money in which the borrower and lender meet directly
with each other to conduct their business. Semidirect finance involves the use of a broker
or dealer to help bring borrower and lender together and, thereby, reduce information
costs. Indirect finance refers to the creation of financial assets by financial
intermediaries who accept primary securities from ultimate borrowers as their principal
earning assets and issue secondary securities to ultimate savers to raise funds.
- Financial intermediaries (such as banks, pension funds, and insurance companies) have
grown to dominate most financial systems today due to their greater expertise, efficiency,
and capability in diversifying away some of the risks involved in lending money.
- One of the most serious management problems encountered by financial intermediaries
is disintermediation—the loss of funds from a financial intermediary to direct or semidirect
finance. Much of the disintermediation experienced by modern financial intermediaries
has occurred due to financial innovation within the global financial system.
Borrowers (issuers of financial assets) have found new ways to obtain the funds they
need without going through a financial intermediary.
- Finally, financial systems around the world appear to fall into one of two broad categories
—bank-dominated financial systems and security-dominated financial systems.
In bank-dominated systems the majority of financial assets arise from the banking system
and when banks get into trouble the financial system itself may experience difficulties
with risk exposure and slower growth. In security-dominated financial systems, on
the other hand, security brokers and dealers tend to be leaders in the financial system
and often provide the greatest volume of funds to those in need of new capital. Thus,
security-dominated financial systems are heavily dependent upon direct and semidirect
finance (i.e., the open market), while bank-dominated financial systems tend to rely
heavily upon financial intermediaries (indirect finance) for the raising of new funds.
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2003 McGraw-Hill Higher Education