FINANCIAL INSTITUTIONS AND

INVESTMENT MANAGEMENT

COURSE INSTRUCTOR : Biruk Ayalew (PhD)

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CHAPTER ONE
PART II

OVERVIEW OF FINANCIAL SYSTEM

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2. Financial Intermediaries
● The term financial intermediary includes all kinds of organizations which
intermediate and facilitate financial transactions of both individual and
corporate customers.
● Financial intermediaries obtain funds by issuing financial claims against
themselves to market participants, then investing those funds.
● Thus, it refers to all kinds of financial institutions and investing institutions,
which facilitate financial transactions in financial markets.

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 QUESTION TIME
Which one of the following is incorrectly stated as to
Depository Intermediaries?

A. They are less regulated

B. most people use their services on a daily basis
C. accept deposits from individuals and firms
D. They are highly
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Cont’d
● The role of financial intermediaries is to create more favorable transaction
terms than could be realized by lenders/investors and borrowers dealing
directly with each other in the financial market.
● This is accomplished by financial intermediaries in a two-step process:
1. obtaining funds from lenders or investors and
2. lending or investing the funds that they borrow to those who need funds.

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 QUESTION TIME
Which one is Classification financial markets by origin?

A. Auction market and Over the counter (OCT) market

B. Equity (Stock) market and Debt market
C. Money market and Capital market
D. Primary Market
CREDITS: Thisand Secondary
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Types of financial institutions
● Financial intermediaries / institutions may be classified in a variety of
ways.
● One of the most important distinctions is between Depository and
Non-Depository Intermediaries.

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Depository Intermediaries
● They are the most commonly recognized intermediaries because most
people use their services on a daily basis.
● Depository institutions issue a variety of checking or savings accounts and
time deposits and they use the funds to make consumer, business and
mortgage loans.
● In other words, they accept deposits from individuals and firms and use
these funds to participate in the debt market, making loans or purchasing
other debt instruments.
● Depository institutions are highly regulated because of the
important role that they play in the financial system.

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Non-Depository Intermediaries
● Sometimes they are called as shadow banking system
● Their regulation is less stringent
● Their major objective is not the payment of interest
● Contractual institutions attract funds by offering legal contracts to the
public in order to protect the savers against potential risks. (like insurance
companies and pension funds)

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Cont’d
● Investment institutions sell shares to the public and invest the proceeds in
stocks, bonds, and other securities. (like investment companies or mutual
funds, finance companies, and real estate investment trusts).
● It includes contractual institutions (like insurance companies and pension
funds) and investment institutions (like investment companies or mutual
funds, finance companies, and real estate investment trusts).

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3. Financial Markets
● A financial market is a market where financial instruments are exchanged.
● A financial market is a market in which funds are transferred from people
who have an excess of available funds to people who have a shortage.
● They facilitate buying and selling of financial assets.
● Financial markets such as bond and stock markets are crucial to
promoting greater economic efficiency by channeling funds from people
who do not have a productive use for them to those who do.

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Cont’d
● Financial markets provide the following three major economic functions:
o Price discovery
o Liquidity
o Reduced transaction costs

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Classification of financial markets
1. Classification by type of financial claim
o Equity (Stock) market
o Debt market
2. Classification by maturity of claim
o Money market
o Capital market
3. Classification by origin
o Primary Market
o Secondary Market

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Cont’d
4. Classification by organizational structure
A. Auction market
● is one where buyers and sellers enter competitive bids simultaneously.
● The price at which a stock trades represents the highest price that a buyer
is willing to pay and the lowest price that a seller is willing to accept.
● markets do not involve direct negotiations between individual buyers and
sellers, while negotiations occur for OTC trades.

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Cont’d
4. Classification by organizational structure
B. Over the counter (OCT) market
● a decentralized market where the participants trade with one another
directly, without the oversight of an exchange.
● do not have physical locations; instead, trading is conducted
electronically.
● dealers act as market-makers by quoting prices at which they will buy and
sell a security, currency, or other financial products.

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Cont’d
5. Other Classifications
A. Foreign exchange markets: which facilitate the trading of foreign
exchange
B. Insurance markets : which facilitate the redistribution of various risk
C. Derivatives markets: which provide instruments for the management of
financial risk (eg. Forward, future and options)

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Functions of the Financial System
● There are seven basic functions of the financial system in modern society.
These are:
1. Savings Function
2. Wealth Function (store of value)
3. Liquidity Function
4. Credit Function
5. Payments Function
6. Risk Function; and
7. Policy Function

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DISCUSSION POINT
● Discuss the concepts of Financial asset,
Financial intermediaries and Financial market
● Discuss about the depository and
non-depository financial institution in Ethiopia.

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(Please discuss your thoughts on the LMS discussion board) 19

ANY QUESTIONS

?
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THANK YOU!

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