FINANCIAL MARKETS: STRUCTURE AND ROLE IN THE FINANCIAL SYSTEM Mini contents · The structure of a financial system
· Functions of a financial system
· The structure and key features of financial markets
· The key features of financial intermediaries
· Major financial market participants
1. Financial system structure and functions
The financial system plays the key role in the economy by stimulating economic growth, influencing economic performance of the actors, affecting economic welfare. This is achieved by financial infrastructure, in which entities with funds allocate those funds to those who have potentially more productive ways to invest those funds. A financial system makes it possible a more efficient transfer of funds. As one party of the transaction may possess superior information than the other party, it can lead to the information asymmetry problem and inefficient allocation of financial resources. By overcoming the information asymmetry problem the financial system facilitates balance between those with funds to invest and those needing funds. According to the structural approach, the financial system of an economy consists of three main components:
1) financial markets;
2) financial intermediaries (institutions);
3) financial regulators.
Each of the components plays a specific role in the economy. According to the functional approach, financial markets facilitate the flow of funds in order to finance investments by corporations, governments and individuals. Financial institutions are the key players in the financial markets as they perform the function of intermediation and thus determine the flow of funds. The financial regulators perform the role of monitoring and regulating the participants in the financial system. Financial markets studies, based on capital market theory, focus on the financial system, the structure of interest rates, and the pricing of financial assets.An asset is any resource that is expected to provide future benefits, and thus possesses economic value. Assets are divided into two categories: tangible assets with physical
properties and intangible assets. An intangible asset represents a legal claim to some future economic benefits. The value of an intangible asset bears no relation to the form, physical or otherwise, in which the claims are recorded. Financial assets, often called financial instruments, are intangible assets, which are expected to provide future benefits in the form of a claim to future cash. Some financial instruments are called securities and generally include stocks and bonds. Any transaction related to financial instrument includes at least two parties:
1) the party that has agreed to make future cash payments and is called the issuer;
2) the party that owns the financial instrument, and therefore the right to receive the payments made by the issuer, is called the investor.
Financial assets provide the following key economic functions.
· they allow the transfer of funds from those entities, who have surplus funds to invest to those who need funds to invest in tangible assets;
· they redistribute the unavoidable risk related to cash generation among deficit and surplus economic units.
The claims held by the final wealth holders generally differ from the liabilities issued by those entities who demand those funds. They role is performed by the specific entities operating in financial systems, called financial intermediaries. The latter ones transform the final liabilities into different financial assets preferred by the public.