Topic 1 DQ 1 May 30-Jun 1, 2024 Briefly discuss the purpose and role that each type of financial institution (depositary, contractual, and investment) play in the U.S. economy. How do each of these institutions intersect with the various types of markets, i.e., capital, money, spot (cash), derivatives, Forex and Interbank, primary, and secondary (inclusive of OTC)?
Topic 1 DQ 1
May 30-Jun 1, 2024
Briefly discuss the purpose and role that each type of financial institution (depositary, contractual, and investment) play in the U.S. economy. How do each of these institutions intersect with the various types of markets, i.e., capital, money, spot (cash), derivatives, Forex and Interbank, primary, and secondary (inclusive of OTC)?
Submitted on:
May 30, 2024, 4:51 PM
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Frank Umoera
May 30, 2024, 5:59 PM(edited)
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The Purpose and Roles of Financial Institutions in the U.S Economy.
Depository Institutions
The main functions of depository institutions, which include credit unions, commercial banks, and savings and loan associations, are to grant loans and receive deposits from both individuals and companies (Midttun, 2021). They are essential to the economy’s process of creating credit and liquidity. They assist with transactions, hold money securely, and provide a range of financial services, including mortgages, savings accounts, and checking accounts. They also support the payment system, which makes safe and easy financial transactions possible (Midttun, 2021).
Intersection with markets:
Capital Markets: They participate in the capital markets indirectly by investing in business and government bonds.
Money Markets: They are important players in short-term debt instruments including Treasury bills, commercial paper, and certificates of deposit, both as lenders and as borrowers.
Spot (Cash) Markets: Provide liquidity by enabling quick settlements and transactions.
Forex Markets: Trade foreign currencies for personal investment goals as well as to satisfy client demands.
Primary Markets: Underwrite and distribute corporate and government bonds to take part in the issuance of new securities.
Secondary Markets: These markets enable the trading of securities by offering brokerage services and keeping stock and bond inventories.
Inter-bank Markets: Short-term lending and borrowing between banks is essential to preserving liquidity.
Contractual Institutions
Mutual funds, insurance firms, and pension funds are examples of contractual entities. In addition to offering services like investment options, retirement benefits, and insurance coverage, they also collect premiums or payments (Hensengerth, 2012). Their role is to pool savings and risks, enabling long-term investment and risk sharing that promotes capital development and economic stability.
Intersection with Markets:
Capital markets: Significant buyers of long-term assets, such as stocks and bonds, that have an impact on capital market activity.
Money Markets: Make short-term investments to satisfy short-term obligations and manage liquidity.
Markets for Derivatives: Hedged risks related to long-term investments and liabilities using derivatives.
Primary Markets: Invest in recently issued securities to provide substantial capital.
Secondary Markets: Manage portfolios by actively trading in already-existing assets, which has an impact on pricing and liquidity.
Foreign Exchange Markets: trade foreign exchange to protect themselves against currency risk associated with their overseas investments.
Investment Institutions
Securities are issued, traded, and managed by investment institutions, which include investment banks, brokerage houses, and hedge funds (Agbloyor, et. al, 2016)
Through underwriting and advising services, they help firms raise capital; through trading activities, they give clients access to investment possibilities and improve market efficiency and liquidity.
Intersection with Markets:
Capital Markets: Play a crucial role in underwriting and distributing new securities and facilitating mergers and acquisitions.
Money Markets: Take part in the short-term finance markets as a lender or borrower.
Derivatives markets: engage in active trading and the creation of derivatives products for arbitrage, hedging, and speculation.
Forex Markets: Trade currencies to make investments and to ease cross-border commerce.
Primary Markets: Distribute and underwrite newly issued bonds and stocks.
Secondary markets: Give investors access to brokerage services and supply liquidity through trading activity.
OTC Markets: Offer a framework for more specialized and adaptable trading arrangements by facilitating the trade of securities not listed on official exchanges.
Conclusion:
In the American economy, each kind of financial institution has a unique but connected function. Contractual institutions manage risk and enable long-term savings and investments, investment institutions promote capital market activity and liquidity, and depository institutions serve as the backbone of the payments system and credit generation. By interacting with different financial markets, these organizations maintain the stability and efficient operation of the financial system.
References:
Brigham, E.F. & Ehrhardt, M. C. (2020). Financial Management; Theory and Practice. Mason, OH: South-Western Cengage Learning
Midttun, A. (2021). Governance and Business Models for Sustainable Capitalism. https://doi.org/10.4324/9781315454931
Hensengerth, O. (2012). Chinese hydropower companies and environmental norms in countries of the global South: the involvement of Sinohydro in Ghana’s Bui Dam. Environment, Development and Sustainability, 15(2), 285–300. https://doi.org/10.1007/s10668-012-9410-4
Agbloyor, E. K., Gyeke‐Dako, A., Kuipo, R., & Abor, J. Y. (2016). Foreign direct investment and economic growth in SSA: The role of institutions. Thunderbird International Business Review, 58(5), 479-497.
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