4. Financial intermediaries play an important role in the financial system List

Question

4. Financial intermediaries play an important role in the financial system

List at least three benefits to the economy due to services provided by financial intermediaries.

How do financial intermediaries INCREASE efficiency of financial markets?

How do conflicts of interest by financial intermediaries make financial markets LESS efficient?   Provide an example.

5. Suppose you live on an island that produces three primary goods that are produced by three individuals as follows:     

Oranges                  Orange Grove Owner

Bananas                  Banana Grower

                          (c) Chocolate                Chocolate Maker

            6. In this island economy, the (a) Orange Grove Owner likes only bananas and the (b) Banana Grower only likes Chocolate. Furthermore, the (c) Chocolate Maker only likes Oranges.

Explain how trade between these three producers can occur.

Will the Orange Grove Owner be able to eat Bananas? Explain.

How will introducing “money” into the island economy benefit these three producers?

Explanation / Answer

4.

Financial intermediaries are the middleman of financial transactions. Examples of financial intermediaries are share brokers, commercial banks, insurance companies, investment banks, etc.

Three benefits are as below:

1. Connective link: Financial intermediaries are the connective like between sellers and buyers. Without them, finding such connections might have been difficult.

2. Taking the risk of financial transaction: Intermediaries used to minimize the risk of financial transaction by the use of cheque, credit card, letter of credit, telegraphic transfer, etc.

3. Advisory help: Intermediaries help their clients by providing financial advice. Suppose a seller can know the actual time for selling shares to get better price.

Intermediaries can increase efficiency of financial market by the use of following:

1. Speculation: Anticipating the market trend is known as speculation. This is required in capital market. Sellers and buyers in this market would be benefited if such speculations are correct. It increases market efficiency.

2. Speedy service: Transferring money from one place to another in a speed improves market efficiency. Account holders of commercial banks need this service.

3. Prompt action: Any sort of discrepancies should be resolved promptly for increasing market efficiency.

Conflict of interest:

This is a common conflict between the intermediaries and their clients. Suppose a loanable fund is charged with higher interest than the prevailing market rate. It creates conflict between the borrower and the intermediary and makes the financial market less efficient.

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