ECS3701 ASSIGNMENT 2 FOR SEMESTER 2
OF 2023
UNIQUE CODE: 768112
, 2.01 Explain how financial intermediaries reduce transaction costs thereby allowing small
savers and borrowers to benefit from the existence of financial markets. [10]
SOLUTION: OPTION 1
Financial intermediaries play a crucial role in reducing transaction costs in financial markets,
which, in turn, allows small savers and borrowers to benefit from these markets.
Transaction costs refer to the expenses and efforts associated with buying, selling, or
managing financial assets. These costs can include brokerage fees, information gathering
costs, paperwork, and time spent on financial transactions.
Financial intermediaries help minimize these costs in several ways:
a. Economies of Scale: Financial intermediaries pool funds from many small savers and
investors into larger portfolios. By managing these aggregated funds, intermediaries
can achieve economies of scale. This means that the cost per unit of managing and
transacting these funds is lower than if each individual saver or borrower had to do it
independently. The cost savings are then passed on to small savers and borrowers in
the form of lower fees or better interest rates.
b. Information and Expertise: Financial intermediaries have the expertise and
resources to conduct thorough financial analysis and due diligence on potential
investments. They can assess the creditworthiness of borrowers and identify
profitable investment opportunities. Small savers often lack the time, knowledge,
and resources to perform these tasks on their own. By relying on intermediaries,
they can access investment opportunities that they might not have been able to
identify or assess individually.
c. Risk Diversification: Financial intermediaries diversify their portfolios by investing in
a wide range of assets or lending to multiple borrowers. This diversification spreads
risk, reducing the likelihood of significant losses. Small savers may not have the
resources or knowledge to diversify their investments effectively, but by entrusting
their funds to intermediaries, they can benefit from risk reduction.
d. Liquidity Provision: Financial intermediaries provide liquidity to investors and
borrowers. They offer the ability to buy or sell financial assets quickly and efficiently.
For small savers, this means they can access their funds when needed without the
delays and transaction costs associated with directly trading in financial markets.
Borrowers can obtain loans more easily and at competitive rates.
e. Information Aggregation: Financial intermediaries collect and aggregate information
from various sources, helping to improve market efficiency. They gather data on
1
OF 2023
UNIQUE CODE: 768112
, 2.01 Explain how financial intermediaries reduce transaction costs thereby allowing small
savers and borrowers to benefit from the existence of financial markets. [10]
SOLUTION: OPTION 1
Financial intermediaries play a crucial role in reducing transaction costs in financial markets,
which, in turn, allows small savers and borrowers to benefit from these markets.
Transaction costs refer to the expenses and efforts associated with buying, selling, or
managing financial assets. These costs can include brokerage fees, information gathering
costs, paperwork, and time spent on financial transactions.
Financial intermediaries help minimize these costs in several ways:
a. Economies of Scale: Financial intermediaries pool funds from many small savers and
investors into larger portfolios. By managing these aggregated funds, intermediaries
can achieve economies of scale. This means that the cost per unit of managing and
transacting these funds is lower than if each individual saver or borrower had to do it
independently. The cost savings are then passed on to small savers and borrowers in
the form of lower fees or better interest rates.
b. Information and Expertise: Financial intermediaries have the expertise and
resources to conduct thorough financial analysis and due diligence on potential
investments. They can assess the creditworthiness of borrowers and identify
profitable investment opportunities. Small savers often lack the time, knowledge,
and resources to perform these tasks on their own. By relying on intermediaries,
they can access investment opportunities that they might not have been able to
identify or assess individually.
c. Risk Diversification: Financial intermediaries diversify their portfolios by investing in
a wide range of assets or lending to multiple borrowers. This diversification spreads
risk, reducing the likelihood of significant losses. Small savers may not have the
resources or knowledge to diversify their investments effectively, but by entrusting
their funds to intermediaries, they can benefit from risk reduction.
d. Liquidity Provision: Financial intermediaries provide liquidity to investors and
borrowers. They offer the ability to buy or sell financial assets quickly and efficiently.
For small savers, this means they can access their funds when needed without the
delays and transaction costs associated with directly trading in financial markets.
Borrowers can obtain loans more easily and at competitive rates.
e. Information Aggregation: Financial intermediaries collect and aggregate information
from various sources, helping to improve market efficiency. They gather data on
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