Читать книгу Fundamentals of Financial Instruments - Sunil K. Parameswaran - Страница 49

First National Bank is accepting deposits at the rate of 3.50% per annum and is lending to companies at 4.50% per annum. Thus, the bank has a margin of 1% of the transaction amount. Now assume that the borrowing companies opt to directly issue debt securities to the public, with an interest rate of 4.00% per annum. If so, the investors would be getting 0.50% more than what they would were they to deposit their funds with a bank. The issuing companies too stand to incur an interest cost that is 0.50% less. Thus, both the parties to the transaction stand to benefit. What we have essentially done is that the profit margin of 1% which was going to the bank has been split 50/50 between the lending public and the borrowing firm. In practice the split need not be 50/50. All that is required is that the total benefit to the two counterparties should be 1%. Hence, a borrower with a high credit rating can directly tap the capital market without going through an intermediary.

Of course, if direct markets were to be all about advantages, then obviously indirect markets will fail to exist. There are certain shortcomings of such markets. One of the major problems in the case of direct markets is that the claims the borrower wants to issue are often not exactly of the type that individual investors want. Such problems could arise with respect to the denomination of the issue, or the maturity of the issue, or both.

For instance, take the case of a firm that is issuing securities with a principal value of $5,000. It will automatically lose access to investors who seek to invest less than that amount. This is known as the denomination problem. Second, in practice, borrowers like to borrow long-term. This is because most projects tend to be long-term in nature, and entrepreneurs would like to avoid approaching the market at frequent intervals in order to raise funds. But lenders usually prefer to commit their funds for relatively shorter periods. Thus, a company issuing debt securities with twenty years to maturity may find that it has few takers if it were to approach the public directly. This is referred to as the maturity problem.

Yet another problem with direct markets is that they are highly dependent on active secondary markets for their success. If the secondary market were to be relatively inactive, borrowers would find it difficult to tap the primary market. This is because most individuals who invest in debt and equity issues place a premium on liquidity and ready marketability, as manifested by an active secondary market. In times of recession, the secondary markets will be less active than normal, and such periods are therefore usually characterized by small and less frequent issues of fresh securities.

Besides, for an issuer of claims, the cost of a public issue can be high. Such issues require a prospectus and application forms to be printed and also require aggressive marketing. This is obviously not cheap. The investment banker has to be paid his fees, which can be substantial in practice. Finally, the issuing firm needs to hire other professionals like lawyers, CPAs, and public relations firms, whose services will also have to be paid for.

As we have discussed, companies that issue financial claims directly to the public find that many potential investors find the denomination and/or maturity of the securities offered to be unsuitable. Financial intermediaries, however, are able to resolve these issues, for they have the ability to invest relatively large amounts and for long periods of time. This is despite the fact that for a depository institution such as a bank, the average deposit may not be for a very large amount, and most deposits tend to be for relatively short periods. We say that such intermediaries are able to perform denomination transformation and maturity transformation.

Intermediaries like banks are able to effect such transformations because they sell their own claims to the public and, after pooling the funds so garnered, purchase financial claims from the borrowing entities. A large commercial bank will have many depositors ranging from those who deposit a few dollars to those who deposit a few million dollars. Similarly, a mutual fund will have investors ranging from those who seek to buy 100 shares to those seeking to acquire 100,000 shares. Since these institutions cumulatively receive funds on a large scale, they can profitably transform the relatively smaller amounts deposited with them into large loans for commercial borrowers. This is the essence of denomination transformation.

As mentioned earlier, most borrowers prefer to borrow long-term due to the nature of the projects they are executing. Lenders, on the contrary, like relatively short-term liquid assets that can be converted to cash on demand. Banks can pool short-term deposits and package them into medium- to long-term loans. They are in a position to do so because the deposits will periodically get rolled over, either because of renewal by existing depositors or on account of new depositors. Similarly, in the case of an open-ended mutual fund, share redemptions during a given day will be accompanied by fresh investments by either existing or new investors.

Financial intermediaries in the indirect market are also able to provide their depositors with risk management and risk diversification. All rational investors dislike risk and are said to be risk averse. This does not, however, mean that people will not take risks while investing. For, after all, every financial market transaction is fraught with a degree of risk. It is just that the magnitude varies from transaction to transaction and from instrument to instrument. The term risk aversion connotes that, for a given level of expected return, an investor will prefer that alternative that has the least risk associated with it. Put differently, while considering an investment in assets with the same degree of associated risk, an investor will choose the security that has the highest expected return. Alternatively, if the choice is between two assets with the same expected return, the investor will choose the one that has lower risk.

Intermediaries like banks have considerable expertise in dealing with risk as compared to individual investors. Thus, investors who lend indirectly through a bank can be assured that their funds will be deployed by the bank after doing a more thorough evaluation of the credit worthiness of the borrower than what they themselves could have done had they chosen to lend directly.

There is another dimension to the role played by banks from the standpoint of risk. We have already discussed the principle of diversification. That is, it is optimal to hold one's wealth in a portfolio of securities. However, in reality it is not easy for an individual investor to construct a well-diversified portfolio. Most individual investors will have a relatively small corpus of funds at their disposal and extensive diversification will be neither feasible nor cost-effective considering the magnitude of transactions costs that they are likely to incur. An intermediary like a bank has a large pool of funds at its disposal and therefore invests across a spectrum of projects from the standpoint of risk. Thus, depositors are assured that every dollar they deposit is effectively being lent to multiple borrowers, thereby ensuring diversification.

Financial intermediaries are also able to derive substantial economies of scale. That is, their fixed costs of operation get spread over a vast pool of transactions and assets. They are therefore able to ensure that they are relatively cost-efficient, and this benefit will be passed on to the depositors to a degree. We will illustrate the concept of economies of scale with a simple illustration.