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Understanding the work of financial markets - Essay Example
Finance & Accounting
Pages 10 (2510 words)
Right from the start, the essay makes sure we understand that it is important to understand how financial markets work. In the financial system, lenders of money include households and firms while borrowers include firms, governments and households…
The essay clearly discusses the role of the banks in bank-based system and market-based systems and the informational problems. Market based systems eliminate informational problems. You find that most information is publicly displayed in the market for public listed companies. Then the essay talks about the possible solution. The solution to this problem is to hire a single monitor to monitor the actions of the borrowers. A single monitor cannot solve this problem alone thus he uses a model of delegated monitoring called diamond model (Diamond 1996 pg 41). Then, risk sharing is discussed. Sharing of risks is one of the most important functions of the financial systems and is often argued that the financial markets are well suited in achieving this goal. Afterwards, the essay talks about the corporate governance role. In most countries, the role of corporate control or agency is weak, and as a result banks have been appointed to act as monitors for a large corporation. Financial crises is another topic that the essay discusses. Banks collect deposits and raise short term funds in the capital markets and invest them in the long term assets. Another important aspect would be that close and durable banking relationships provide better access to clients and eliminate some of the information problems associated with lending. Banking relationships can either be multiple or single. In this report, we have pointed out and discussed the role of banks in the financial systems, comparisons between bank –based and market based systems and their merits and different. ...
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