Financial Intermediaries - Essay Example

Financial Intermediaries Introduction Financial intermediaries refer to institutions, individuals or firms that play the intermediation role in a financial context, between parties. These parties are typically a service or product provider, as the first party, and customer or consumer, second party. They are non-banking and banking institutions which transfer funds to economic agents with a deficit unit from economic agents with surplus units. Two types of financial intermediaries exist namely bank financial intermediaries, like commercial banks and central bank, and non-bank financial intermediaries, (mutual trust funds, insurance companies , investment companies, discount houses, pension funds, and bureau de change). The borrowers of money from financial institutions usually pay a higher amount of interest than what the actual lender receives and the difference between interest earned and interest paid becomes the profit of the financial intermediaries (Siklos, 2001). The broad category of financial intermediaries are advisory financial intermediaries or fee-based and asset bases financial institutions. Advisory or fee-based financial intermediaries give advisory financial services at a fee according to the service rendered. These services include underwriting, issue management, corporate counseling, portfolio management, stock broking, mergers and acquisitions, debenture trusteeship and capital restructuring among others. Asset based institutions offer financial help to their clients, according to their specific need they earn income from the difference between interest earned and interest paid. Role of Financial Intermediaries Financial intermediaries have played a key role in poverty eradication, by financially supporting their customers with investment funds. Their main 21st century role is providing financial services through innovative ways to the poor in order to increase their capacity of production and quality of life (Siklos, 2001). Since majority of the poor live in rural areas and only depend on agriculture, they are prune to many risks because of income fluctuations. On the other hand, they cannot access insurance markets and conventional credit to offset this. The poor rarely access funds from many formal financial intermediaries due to fear of high risks and costs that are involved in small transactions that are not profitable and the poor are unable to provide collateral security to these institutions. Financial institutions also provide markets for assets of firms by liquidation and restructuring of firms that are in distress. They play a key role in displaced capital reallocation and reorganization under bank management and supervision. In this case, they sell assets in order to recover bank loans. When they know the synergies existing among firms, they suggest efficient solutions like corporate control and assets reallocation. Siklos asserts that healthy firms search for displaced capital of firms that have become bankrupt, although this may make firms acquire machines that are unsuitable for them. Financial intermediaries also act as centralized markets where they provide ready information on buyers and machines, thus allowing capital, which is displaced, to move to uses that are its productive. As matchmakers between firms and savers, they play the role of internal assets’ market in credit markets. This is economically positive as increase in productive matches in the market increases the number of second hand users who are highly productive in the market of decentralized resale. This reduces firms incentives to address financial institutions for their re-deployers’ ability. Quality improvement in markets is small and prevails better, thus supporting them as assets’ internal markets. As financial intermediaries, pension funds collect pool and funds contributed by beneficiaries and sponsors is invested to provide money for pensioning beneficiaries’ entitlements (Lynch, 1993). Thy therefore help individuals to accumulate savings during their working life in order to finance their needs after retirement, by either lump sum or annuity. At the same time, end users like other house holds, government and corporations are also supplied with funds for consumption and investment. The economic function of pension funds in financially stimulating and changing the financial landscape is in settling and clearing payments, mechanism of pooling of shares and funds. Additionally, they provide ways of economic transfer of resources and ways of controlling risks and managing uncertainties. They also provide price information and ways of dealing with incentives. Fidelity Magellan Fund Financial Intermediary as Run by Peter Lynch Fidelity Magellan Fund is a mutual fund in US from the funds of fidelity family. In the entire world, it is the mutual fund that is known as the best and actively managed. According to Mahar (2004), Peter Lynch ran this institution for thirteen years, leaving an AUM record of $ 13 billion. In 1968, the annual funds returns were 116.08%, registering a marked growth in assets. During his reign, the firm registered an annual return of 29%, through his commonly known investment process of buy what you know. The financial intermediary, Fidelity Magellan Fund, run by peter lynch was always ranked at the top in funds of general mutual equity. In 1977, investing $ 1,000 in this financial intermediary translated into $ 28,000 in 1990 (Lynch, 1993). Lynch was therefore called the number one manager in the world and now, he still shows investors how to put investment techniques and philosophy into actions. Lynch really translated the world of financial intermediaries by making the economy better off. This company was highly trusted by investors and this really boosted the economy, by eradicating poverty through investment. People who were able to borrow funds from Fidelity Magellan Fund financial intermediary were able to repay it well and boost their capital productivity and quality of living. Like other financial intermediaries, fidelity earns income from charged fees on assets under its management. Peter lynch being vetted as the most successful manager in the whole history of Fidelity Magellan in the whole century inherited a meager $20million from his predecessors but managed to boost its worth to a staggering $30billion AUM for a period of 13 years (Sullivan, 2003). This positive forward management strategy pushed fidelity Magellan assets to $100billion that were directly under its management at the end of the 20th century. This positively contributed to the economic development of us, and positively transformed the lives of its customers and investors. Factors that helped lynch achieve and help the economy to grow were his mottos like telling people that they must invest only in what they know. He only invested in industries that he knew very well. He did this by concentrating on what he knew and was well familiar with in order to avoid risks and uncertainties of unknown investment opportunities. Further more, he made sure that that industry was operating at glamour spectrum of the dim end. During his reign in Fidelity Magellan Fund, the institution demonstrated high price, profitability, and a perfect business model. This assured him that his business was making money, attractive stock price and that the business had a competitive advantage. For a financial intermediary to boost the economy, lynch says that investors must look into the key numbers when looking at business fundamentals. Investors should therefore invest in companies that are in a strong financial position. But stay away from those with high ratios of debt to equity. Slow and cyclical stock growers companies should as well be avoided and when excited by a certain service or product, an investor should ensure that it sufficiently accounts for the total sales of a company. His advice to people is that they should avoid holding cash so as to avoid missing market upswings has helped many people to invest, thus boosting their living standards and economic growth and development in the wider perspective. To be a good businessman, one should not fear the ups and downs of the economy. This helped US citizens a great deal in economically investing their funds. Moreover, it boosted the US economy through increased investments that strengthened their economic financial base, rendering the economy to be better off. Good management of the company also helped it achieve its goal as well as that of the economy. Lynch observes that for a financial intermediary to be successful, managers should be investor oriented and very competent in running the business. Investors should also base their sell and buy decisions on specifics as profits and losses are not only determined by the economy. Sell stocks when prices are high, and buy when they are low. Peter Lynch’s advice and principles in the financial intermediaries industry has seen the company successful, not mentioning the great heights it lifted the US economy. Conclusion Financial intermediaries have greatly helped to boost economic development, besides improving people’s quality of living. They have played a key role in eradicating poverty through financial support to the poor, as well as increasing the capital base of investment. Peter Lynch is without doubt the greatest master investments of our times. His easy understanding of publication and styles of investment are valuable to infant investors. References Lynch, P. (1993). Beating the Street. New York: Simon & Schuster. Mahar, M. (2004). "Bull! A History of the Boom and Bust, 1982-2004”. Harper Collins Publishers. Siklos, P. (2001). Money, Banking, and Financial Institutions: Canada in the Global Environment. Toronto: McGraw-Hill Ryerson. Sullivan, A. (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. Read More