Page 507 - Introduction to Business

CHAPTER 14 Understanding the Financial System, Money, and Banking 481

With a few clicks of the mouse on a computer screen, professional and individual
investors can easily make securities transactions. Market orders are executed at the
prevailing market price determined by supply and demand forces, while limit
orders are executed at a set price (e.g., the highest or lowest price at which a person
is willing to buy or sell, respectively). An automated trading system scans the net-
work for matching orders and either immediately executes the order or posts the
order for later execution or cancellation.

Financial Markets. Financial markets can be classified as public versus pri-
vate and primary versus secondary. In the public market a security is offered for sale
to virtually any buyer, whereas a private sale is available only to selected buyers. In
the corporate bond market it is common for firms to privately issue their bonds to
large institutional buyers, such as life insurance companies and pension funds. The
primary market is the initial sale of a security in the financial marketplace, in con- primary market The initial sale of a
trast to the trading of outstanding issues in the secondary market. The secondary security in the financial marketplace
market is much larger than the primary market in terms of trading volume. secondary market The trading of
Nonetheless, the primary market can be quite interesting when a firm issues equity outstanding securities in the financial
marketplace
for the first time in public securities markets (i.e., an initial public offering or IPO) or
when firms issue a large amount of debt to finance a major expansion.

Financial Institutions. Financial institutions are privately owned firms that financial institutions Privately owned
provide payment, deposit, credit, securities, and other services. Like any firm, they firms that provide financial services
seek to maximize the value of their common stock shares. Unlike other nonfinan-
cial firms, they are heavily regulated due to their importance in the national econ-
omy. Many financial institutions act as intermediaries that channel savings of indi-
viduals to investments of business firms.
Exhibit 14.1 illustrates the process of financial intermediation in the financial financial intermediation The process of
system. Small savings of individuals are pooled in various financial institutions in pooling individuals’ savings in financial
institutions that channel them to
exchange for indirect securities (e.g., bank accounts, insurance policies, and pen-
business firms
sion fund plans). Subsequently, institutions invest savings in the direct securities
(e.g., loans, bonds, and common stock) issued by business firms. Savers gain the
benefits of convenience, record and safekeeping services, alternative investment
options, and financial expertise. Business firms benefit from payments services,
debt and equity supplies of funds, and financial expertise.
While financial intermediation has obvious benefits for both savers and
business firms, its implications for the institutions themselves are quite complex.
Small, safe, short-term savings are converted by institutions into large, risky, and

EXHIBIT 14.1
The Process of Financial Intermediation

Financial Intermediaries
Depository Institutions
Savings are • Banks Savings are
Savers pooled in • Thrift institutions invested in Investors
(individuals) financial Nondepository Institutions business firms (businesses)
institutions
• Life insurance companies
• Pension funds
• Investment companies

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