ECS3701
Assignment 2
(ANSWERS)
Semester 2
2023
ADMIN
[COMPANY NAME]
, 2.01 Explain how financial intermediaries reduce transaction costs thereby
allowing small savers and borrowers to benefit from the existence of financial
markets. [10]
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
associated with buying or selling financial assets or obtaining loans. Here's
how financial intermediaries help in this regard:
1. Economies of Scale: Financial intermediaries, such as banks and mutual
funds, pool together funds from numerous small savers. By aggregating
these funds, they can achieve economies of scale in various activities,
including investment, lending, and transaction processing. This means that
the per-unit transaction costs are lower when dealing with large sums of
money. Small savers who individually couldn't access these economies of
scale can benefit from lower transaction costs when their funds are managed
collectively.
2. Expertise and Information: Financial intermediaries have access to financial
experts and information resources that small savers might not possess.
These experts can analyze investment opportunities, assess credit risks, and
make informed decisions on behalf of their clients. By relying on the
expertise of intermediaries, small savers can reduce the costs associated
with conducting extensive research and analysis themselves.
3. Diversification: Financial intermediaries often create diversified portfolios of
assets, spreading risk across a range of investments. This diversification can
help mitigate risk for small savers. Without intermediaries, small savers
might be limited in their ability to diversify, as they might not have enough
capital to invest in a broad range of assets. Reducing risk through
diversification can indirectly lower transaction costs by decreasing the
likelihood of large losses.
4. Liquidity Provision: Financial intermediaries offer liquidity by providing
secondary markets for various financial assets. This liquidity ensures that
small savers can easily buy or sell their investments without incurring
significant transaction costs. Without these intermediaries, small investors
might face illiquidity, which can lead to higher transaction costs when trying
to exit investments quickly.
5. Risk Management: Financial intermediaries can also provide risk
management services, such as insurance and hedging products. Small
borrowers can benefit from these services by protecting themselves against
unforeseen events, such as interest rate fluctuations or natural disasters.
These risk management tools can reduce the overall cost of borrowing for
small businesses and individuals.
Assignment 2
(ANSWERS)
Semester 2
2023
ADMIN
[COMPANY NAME]
, 2.01 Explain how financial intermediaries reduce transaction costs thereby
allowing small savers and borrowers to benefit from the existence of financial
markets. [10]
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
associated with buying or selling financial assets or obtaining loans. Here's
how financial intermediaries help in this regard:
1. Economies of Scale: Financial intermediaries, such as banks and mutual
funds, pool together funds from numerous small savers. By aggregating
these funds, they can achieve economies of scale in various activities,
including investment, lending, and transaction processing. This means that
the per-unit transaction costs are lower when dealing with large sums of
money. Small savers who individually couldn't access these economies of
scale can benefit from lower transaction costs when their funds are managed
collectively.
2. Expertise and Information: Financial intermediaries have access to financial
experts and information resources that small savers might not possess.
These experts can analyze investment opportunities, assess credit risks, and
make informed decisions on behalf of their clients. By relying on the
expertise of intermediaries, small savers can reduce the costs associated
with conducting extensive research and analysis themselves.
3. Diversification: Financial intermediaries often create diversified portfolios of
assets, spreading risk across a range of investments. This diversification can
help mitigate risk for small savers. Without intermediaries, small savers
might be limited in their ability to diversify, as they might not have enough
capital to invest in a broad range of assets. Reducing risk through
diversification can indirectly lower transaction costs by decreasing the
likelihood of large losses.
4. Liquidity Provision: Financial intermediaries offer liquidity by providing
secondary markets for various financial assets. This liquidity ensures that
small savers can easily buy or sell their investments without incurring
significant transaction costs. Without these intermediaries, small investors
might face illiquidity, which can lead to higher transaction costs when trying
to exit investments quickly.
5. Risk Management: Financial intermediaries can also provide risk
management services, such as insurance and hedging products. Small
borrowers can benefit from these services by protecting themselves against
unforeseen events, such as interest rate fluctuations or natural disasters.
These risk management tools can reduce the overall cost of borrowing for
small businesses and individuals.
