Role Of The Us Financial System

Role of the US Financial System

"Financial markets are the meeting place for people, corporations, and institutions that either need money or have money to lend or invest. In a broad context, the financial markets exist as a vast global network of individuals and financial institutions that may be lenders, borrowers, or owners of public companies worldwide. Participants in the financial markets also include national, state, and local governments that are primarily borrowers of funds for highways, education, welfare, and other public activities; their markets are referred to as public financial markets." (Block & Hirt, 2005)

A financial market is a mechanism which allows people to trade money for securities or commodities such as gold or other precious metals. In general, any commodity market might be considered to be a financial market, if the usual purpose of traders is not the immediate consumption of the commodity, but rather as a means of delaying or accelerating consumption over time. (Wikipedia Encyclopedia)

Financial markets are affected by forces of supply and demand, and allocate resources over time through a price mechanism such as the interest rate. Typically financial markets use a market making or a bid and ask process.

Financial markets facilitate:

* The raising of capital (in the capital markets);

* The transfer of risk (in the derivatives markets); and

* International trade (in the currency markets).

The first article that I would like to review is written by Linda Himelstein, "Time to End Friends-and-Family Shares". The article declares that " IPO shares earmarked for a favored few hurt their issuers and other stockholders". The article discusses the scenario when a particular corporation went public and declined to offer any friends-and-family shares, simply because they thought it was not worth the trouble of considering who and who not to offer these stocks. However, this is not how most companies think, "which is why federal regulators need to adopt an outright ban on friends-and-family programs" (Businessweek Online, 2006).

The article concludes that, "The temptation to hand out preferential shares to influential managers in key decision-making positions is, for some, irresistible. As a four-month BusinessWeek investigation demonstrates, the conflicts created by an individual's personal financial stake in business partners can result in behavior that hurts both the employer and shareholders." (Businessweek Online, 2006).

The second article I would like to review is by Karen E. Klein, "The Capital Gender Gap" which confers that despite the health and proliferation of female owned businesses, women use less commercial credit, and rely more on business earnings as their primary funding source. This conclusion was reached due to a study conducted to measure key trends in business financing, capital availability, and equity capital for women business owners over the past decade. According to the study, 20% of female business owners used commercial credit in 1996, and by 2003, this figure was up to 34%. Another interesting observation was that "as of 2004, women control about half of the 20 million privately owned businesses nationwide, and the number of women owned businesses is growing twice as fast as the number of male owned businesses."(Businessweek Online, 2005)

The Process of Raising Capital

The process of raising capital to fund a start-up or an early stage developing business can be a very complex and intimidating experience for a corporation. Yet, it is an experience a corporation needs to confront in order to start or grow its business. "The reality is that raising capital is an area for which the corporation will need to seek outside expert advice e.g. legal, accounting and perhaps investment banking. These advisors are familiar with federal and state securities laws and should have technically competent and have been through this process many times before" (Himelstein, 2006). Without the innovative techniques, large corporations would not able to grow.

The following table by Wikipedia Encyclopedia illustrates where financial markets fit in the relationship between lenders and borrowers:

Relationship between lenders and borrowers

Lenders Financial Intermediaries Financial Markets Borrowers

Individuals

Companies Banks

Insurance Companies

Pension Funds

Mutual Funds Interbank

Stock Exchange

Money Market

Bond Market

Foreign Exchange Individuals

Companies

Central Government

Municipalities

Public Corporations

Corporations have five primary methods of obtaining money:

Issuing Bonds

A bond is a written promise to pay back a specific amount of money at a certain date or dates in the future. During the life of the bond the bondholders receive interest payments and they even sell bonds before the due date of the bond. Capital raising through bonds can benefit the corporation in two ways; it can raise funds through bonds at lesser interest rate than other types of borrowings and the interest paid on bonds is considered tax deductible business expense. The disadvantage is the compulsory interest payment even if the corporation is showing losses. If a corporation's ability of generate profit is in doubt, investors will not invest in bonds or will tend to demand higher interest rate to compensate the risk factor.

Issuing Preferred Stock

Another method of raising capital is to issue preferred stock. The investors of such shares get privilege in payment of dividends. The buyers have special status in the event the underlying company encounters financial trouble. If profits are limited, preferred-stock owners will be paid their dividends after bondholders receive their guaranteed interest payments but before any common stock dividends are paid.

Selling Common Stock

If a company

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