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Essay on Roles of Financial Institutions in Our Economy

Date:  2021-05-26 09:42:11
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Any firm that conducts financial transactions such as loans, investments and deposits are referred to as financial institutions. Financial institutions are imperative to the economy of a country and everyone deals with one either directly or indirectly. Most transactions in the lines of taking loans, investing and even exchanging currencies are done through financial institutions. Therefore, on a regular basis, everyone is affiliated with a financial institution. There are different types of financial institutions, and each serves a particular purpose. Below is an overview of some of the significant categories of financial agencies and the respective roles they play in the economy and financial system.

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1. Commercial Banks

Commercial banks are the most popular and used type of financial institution. They accept deposits hence, providing both security and convenience to their clients. Commercial banks reduce the crime rate in a country in that, people can secure their cash by making bank deposits and do not have to carry it around risking loss due to accidents or theft. Secondly, they make loans to individuals and companies which are used for personal expenses and expansion of businesses. An increase in business operations in a country develops its economy.

2. Insurance Companies

Insurance companies contribute positively to the economy of a country by coming through in trying times. Insurance companies help individuals and enterprises to stay stable in hard times and manage risks with the aid of wealth preservation. People and businesses can be insured against certain losses that are likely to paralyze income generation. Examples of such losses include fire, accidents, theft, sickness and even death. In the event of any of these instances, the individual or company incurs a loss that if not careful may have adverse effects. However, with the right insurance, this should not be a cause of worry.

In conclusion, financial institutions have a primary role in ensuring that there is liquidity in the countrys economy. They also make it possible for individuals and companies to transact higher levels of economic activities CITATION Fre98 \l 1033 (Mishkin, 1998).

Differences between Primary and Secondary Markets

The total of potential buyers and sellers in a particular region is referred to as a market. The region may be a city, state, country or even the earth. Markets are divided into two broad categories namely: primary market and secondary market. A primary market involves the creation of securities whereas a secondary market is investors oriented. Below is a comparison of the two markets.

1. Primary Market

Securities are created in a primary market. New stocks and bonds first find their way to the public through the primary market. A common term associated with the primary market is the Initial Public Offering (IPO) which is the process by which a private company releases its stocks to the public for sale for the first time. In a primary market, there are no intermediaries and securities are purchased directly from the company that is issuing them. There are a couple of regulations that dictate a primary market which is both legal and financial in nature.

2. Secondary Market

A secondary market is also popularly referred to as a stock exchange. All currency exchanges worldwide fall under this category. It does not directly involve the issuing company, and the investors are at will to trade among themselves without seeking any permission from the enterprise. The main item of commerce in the secondary market is previously issued securities. No new securities are created, and the nature of trade is based on the change of ownership of the securities among the investors.

In conclusion, the main difference between primary and secondary market is the item of trade, nature of traders and the extent of involvement of the issuing company CITATION EGo10 \l 1033 (Gordon & Natarajan, 2010).

Differences between Money and Capital Markets

A financial market focusses substantially on the assets and how they can be acquired. There are two ways to which such can be achieved: money market and capital markets. Money markets are preferred on a short-term basis. Financial instruments that are characterized by high liquidity and short maturities typically less than a year use money markets as their preferred form of trade. On the other hand long term assets with a long-term maturity that is over a year deal in long term markets. Both markets comprise a significant portion of the financial markets, and together they are used to manage risks and liquidity.

Capital markets are widely followed as compared to money markets. Examples of capital markets include stock and bond markets. Capital markets are usually more scrutinized as they are capable of affecting world markets at a larger scale. Capital markets include nonbank institutions such as mortgage banks and insurance companies. Capital markets have a broad scope and focus on the long term. Businesses trading in capital markets are more stable and have greater tendencies to grow and expand.

Money markets are designed for the fewer risk takers. People who want quick money and do not have the patience of waiting for returns in capital markets. Whereas capital markets are associated with long-term securities, money markets are affiliated with liquidity CITATION Jef04 \l 1033 (Madura, 2004).

References

BIBLIOGRAPHY Gordon, E., & Natarajan, K. (2010). Financial mrkets. Mumbai: Himalaya Pub. House.

Madura, J. (2004). Financial markets. Vol.1. London: Sage publications.

Mishkin, F. S. (1998). The economics of money, banking, and financial markets. Reading: Addison-Wesley.

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