Financial Intermediaries Role in the Financial Markets |  Essentials of Investments | CFA
Channel: Farhat Lectures. The # 1 CPA & Accounting Courses
Date: 2020-06-08

IN this video, I explain the role of financial intermediaries.  Financial intermediaries are entities that acts as the middleman between two parties in a financial transaction, such as a commercial bank, investment bank, mutual fund, or pension fund.  Also, financial intermediaries could be an institution or individual that serves as a middleman among diverse parties in order to facilitate financial transactions.

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From a bird’s-eye view, there would appear to be three major players in the financial markets:

Firms are net demanders of capital. They raise capital now to pay for investments in plant and equipment. The income generated by those real assets provides the returns to investors who purchase the securities issued by the firm.

Households typically are suppliers of capital. They purchase the securities issued by firms that need to raise funds.

Governments can be borrowers or lenders, depending on the relationship between tax revenue and government expenditures. Since World War II, the U.S. government typically has run budget deficits, meaning that its tax receipts have been less than its expenditures. The government, therefore, has had to borrow funds to cover its budget deficit. Issuance of Treasury bills, notes, and bonds is the major way that the government borrows funds from the public. In contrast, in the latter part of the 1990s, the government enjoyed a budget surplus and was able to retire some outstanding debt.

Households want desirable investments for their savings, yet the small (financial) size of most households makes direct investment difficult. A small investor seeking to lend money to businesses that need to finance investments doesn’t advertise in the local newspaper to find a willing and desirable borrower. Moreover, an individual lender would not be able to diversify across borrowers to reduce risk. Finally, an individual lender is not equipped to assess and monitor the credit risk of borrowers.

For these reasons, financial intermediaries have evolved to bring together the suppliers of capital (investors) with the demanders of capital (primarily corporations and the federal government). These financial intermediaries include banks, investment companies, insurance companies, and credit unions. Financial intermediaries issue their own securities to raise funds to purchase the securities of other corporations.