Financial Intermediaries

 An instituion or individual that serves as middleman among diverse parties in

order to facilitate financial transaction.
 Financial intermediaries are essential for the growth of a country. They act as the
backbone of the economy and facilitates the circulation of money in the market
from the individual’s households and accounts.
 Lender: Deposit the money to the bank. They are the one that lend money to the
bank
 Borrower: To whom the bank lends money

Types of Financial Intermediaries

 The Banking System
a) Federal Reserve banks (Ex: Bangko Sentral ng Pilipinas)
b) Commercial banks (Ex: BPO, BDI, MetroBank)
c) Saving banks
d) Postal saving system
 Other depository organization
a) Savings
b) Loan associations
c) Credit unions: These are the cooperative financial units which facilitate lending
and borrowing of funds to provide financial assistance to its members.
 Insurance organization
a) Private life insurance organization
b) Private non-insured pension funds
c) Government insurance
d) Pension funds
e) Property insurance companies
 Other financial intermediaries
a) Investment companies
b) Land banks: For property loan purposes (Housing)
c) Mortgage companies: Focus on unit loan (condo), long-term (15-30 years).
“Magsasanla ng property.”
d) Finance companies: Set the terms and condition of payment depending on the
borrower ability to pay. (Home credit)
e) Security brokers and dealer: Brokers help clients buy and sell securities while
overseeing their brokerage accounts, while dealers are individuals or firms that
buy and sell securities for their own accounts.
f) Government lending institutions

Functions of Financial Intermediaries

 Convert saving into investment: Assets that generate returns (Stocks, real estate,
bonds)
 Provide cash facilities: It serves as a safe place to store money for lenders.
  Assist clients to grow their investment: By providing loans for borrowers, and
terms depended on both parties.
 Assist clients to grow their investment: Lenders are at high risk when they
provide loans to the borrower.

Benefits of Financial Intermediaries

 Lowers the default risk: Intermediaries process all legal processes and fix the
portfolio to minimize risk.
 Saves time and cost: They analyze all the opportunities for investment and do all
paper works and administrative tasks.
 Helps customize services for clients
 Lowers the problem of asymmetric information: They gather and analyze
information (investment and risk). Accurately assess the risk and potential returns
on different investments.

Drawbacks of Financial Intermediaries

 Low return investment: The ultimate aim of the FI is to earn a profit and
therefore, they usually provide a low rate of interest on the investment made by
the depositors.
 Opposing goals: The goals of the investors and the financial intermediaries may
not complement each other, and therefore the objective of one may not be
achieved.
 Fees and commissions: These intermediaries impose charges, expenses and
commission on the financial assistance they provide to their customers.
 False Opportunities: FI come up with the investment opportunities which
guarantee high potential returns with the hidden risk involved in it.
 Higher interest on loan: These financial intermediaries charge a high rate of
interest on the loan provided to the borrowers to earn a profit.
Interest Rate Risk
Interest Rate
 Amount charged over and above the principal amount by the lender from the
borrower.

Interest Rate Risk

 Potential that a change in overall interest rates will reduce the value of a bond or
other fixed-rate investment.
Note: If the Interest Rate goes up then the bond values go don (vice versa)

A bond is a fixed-income instrument by a loan made by the investor.

Two kinds of Bonds

Short-term bonds
– It has a lower interest rate risk
– Less movement in terms of prices
– Possible to face the re-investment risk
Long-term bonds
– It has a higher interest rate risk
– Sensitive in the movement of Interest rate
– Possible to face price risk

Price Risk is the changes in bond value.

Bond value depends on the maturity rate level or yields to maturity (Interest rate).

Types of Interest Rate Risk

 Price Risk – It is the risk that security’s price will change, which would cause an
unforeseen gain or loss when the investment is sold.
 Reinvestment Risk – It refers to the danger that the interest rate will change, thus
making it impossible to reinvest at the existing investment rate.
 Duration Risk – This risk relates to the potential for unintentional
prepayment or an extension of the Investment past the planned time
frame.
 Basis Risk – This refers to the possibility that assets having inverse
attributes will not behave exactly in the opposite way as Interest rates
change.

By properly managing interest rate risk, you can:

 Lock the interest rate level - To reduce risks brought on by an increase in
interest rates, you can switch your debt's exposure to floating to fixed interest
rates.
 Reduce the cost of borrowing under adverse market conditions - To reduce
the risk of interest rate fall, you can shift loan interest rate exposure from fixed to
floating.
 Manage the asset and liability flexibly - You can use interest rate hedging
methods to alter your portfolio without selling any assets or paying off the debt
earlier than intended in order to reduce the risk of your portfolio being negatively
impacted by interest rate changes.