Financial flows and Markets
• Financial assets is a paper claim by one
economic unit on some other economic unit.
It does not provide its owner with the physical
services/labour that a real /fixed asset does
Financial assets are held as a store of value for
the return what they are expected to provide
Holding these assets (except equities) does
not indicate neither direct nor indirect
ownership of real assets in the economy .
• Financial assets are interrelated to savings
Savings are in the Keynesian terms Y-C = S or
current income minus current expenditures .
They are held by households /joint family
partnerships,NGOs, companies, government and
their units . Financial assets facilitate capital
formation or investment. All tangible assets such
as land, buildings ,plant &machinery ,inventories
constitute capital formation .
• In the absence of financial assets , economy would not
be able to function dynamically and it would not be
having value over time . All economic units would be
willing to lend to /borrow from each other and that
constitutes interrelationships or claims . Households
are saving surplus units and they lend to companies
which are saving deficit units . Financial markets
including banks are the intermediaries ,who facilitate
this lending /borrowing between the units .
Governments have set up regulatory bodies to
supervise and monitor the functioning of these bodies
in a coordinated and smooth manner.
Efficiency and economics in financial
• The purpose of financial markets is to allocate
savings /financial assets efficiently across various
economic units . Financial markets help in
achieving balance between saving surplus units
(Hh)and saving deficit units (Bu)
• Efficient financial markets are essential to assure
adequate capital formation and economic growth
in a modern economy and without that efficient
level, the economy would be static , traditional
and narrow .
Stages of economic efficiency
• In a modern economy, primary units lend their
savings to financial intermediaries/markets and
they constitute primary securities. Value creation
happens through claims and allocation of
financial assets/liabilities between the various
economic units . Direct loans may not be
sufficient in creating /service asset formation in
each other. Brokers are financial intermediaries
and they help in negotiating and assembling
convenient multiple loans .
Stages of economic efficiency
• Secondary markets including stock exchanges
enhance the flow of savings in an economy
where existing securities are bought /sold and
thus the markets become viable , flexible and
efficient. Securities become marketable by
having and retaining value across transactions
and markets .The prices and yields reflected in
this market provide a rational basis for
borrowing/lending decisions in the primary
market and pricing new loans and activities .
Role of financial intermediaries
• Financial intermediaries help in creating value and
transactions across exchanges /markets .
• Financial intermediaries provide a variety of services –
- Reduction of transaction costs
- Information thru documents /agreements and
dissemination and analysis &appraisal
- Divisibility &flexibility
- Diversification across securities ,risks &return
- Expertise and convenience
Role of Financial intermediaries
• Financial intermediaries tailor the
denomination and type of indirect securities
they issue to savers and they make a profit in
the transaction which makes their business
viable and efficient.