The investment environment - The players

Question

What are the three major players in the financial markets?

Answer 1

1. Firms are net borrowers

2. Households typically are net savers

3. Governments can be borrowers or lenders, depending on the relationship between tax revenue and government expenditures.

Answer 2

First, households want desirable investments for their savings, yet the small (financial) size of most households makes direct investment difficult. Second, a small investor seeking to lend money to businesses that need to finance investments doesn’t advertise in the local news- paper to find a willing and desirable borrower. Third, an individual lender would not be able to diversify across borrowers to reduce risk. Fourth, an individual lender is not equipped to assess and monitor the credit risk of borrowers.

Answer 3

First, by pooling the resources of many small investors, they are able to lend considerable sums to large borrowers. Second, by lending to many borrowers, intermediaries achieve significant diversification, so they can accept loans that individually might be too risky. Third, intermediaries build expertise through the volume of business they do and can use economies of scale and scope to assess and monitor risk.