Major Players in the Financial Markets
There are three major players in the financial markets:
- Firms and
households are net savers hence they supply funds to firms and the government by buying securities and earning income on their funds. Firms are net borrowers. They raise funds by issuing securities and investing in productive assets. The income from these assets is distributed to suppliers of funds (shareholders and lenders). The government can be the borrower or the lender. When there is a budget deficit (tax revenue falling short of expenditures) it borrows. When there is a budget surplus, it lends (or retires debt). Nepal Government has always been the net borrower to date. Between the ultimate borrowers (e.g. firms) and the ultimate lenders (e.g. households) lie other important intermediaries in the financial markets. They are financial intermediaries, investment bankers, and venture capital and private equity partners.
Also Read: Investment Process
In the foregoing paragraph, we grouped three major players in an economy (households, businesses, and government) into two groups — net savers and net borrowers. How do funds move from net savers (surplus units) to net borrowers (deficit units)? There are two processes — direct financing and indirect financing. In direct financing, the surplus unit supplies funds directly to the deficit units by buying the securities issued by the deficit units. Direct financing takes place when an investor (sea-plus unit) buys stocks or bonds issued by a corporation in the primary market. Direct financing, though very useful, has serious limitations. For example, the surplus unit’s savings may be too small to buy securities, or the security’s maturity period does not match that of the issuer, or the surplus unit is unable to analyze the risk and return involved in the security. Financial intermediaries came into existence to do away with these limitations of direct financing. Financial intermediaries issue their own securities suitable to the savers and collect funds in their own accounts. Then, they lend it by buying the securities of the deficit units and bear the risk.
Also Read: Financial Markets and the Economy
Thus, financial intermediaries come in between ultimate savers and ultimate borrowers and facilitate the fund transfer process. Banks, finance companies, insurance companies, investment companies, and pension funds are examples Of financial intermediaries. When intermediaries are involved, there is indirect financing the fund of the savings unit goes to the deficit unit via financial intermediaries. For example, investment companies pool and manage the money of many investors. They run mutual funds primarily for small investors and also design portfolios for large investors. They offer professional management services and enjoy economies of scale in operation. In Nepal, however, their role, though growing, is still insignificant.
Also Read: Real Assets Vs Financial Assets
Investment bankers act as an intermediary between issuers and the ultimate purchasers of securities. They underwrite and manage the issue of securities as well. They also advise the issuing companies on the types of securities to be issued, the price to be charged, issue timing, etc. At this point, the readers should not be confused and take investment bankers as examples of financial intermediaries. It is because investment bankers do not issue their own securities and create liability in their own accounts which financial intermediaries do. Investment bankers merely help in the fund transfer process between issuers of the securities and investors. In Nepal, the same company functions as an investment banker as well as an investment company making their distinction difficult. For example, Nabil Capital Ltd or Siddhartha Capital Ltd function as issue managers as investment bankers and run mutual funds as investment companies.
Also Read: Meaning of Investment
VENTURE CAPITAL AND PRIVATE EQUITY:
Venture capital funds are usually set up as limited partnerships to fund startup companies. A management company starts with its own money and raises additional capital from a few partners such as pension funds, insurance companies, wealthy individuals (known as angel investors), etc. The fund is then invested in new and small firms that are unable to raise funds directly from the markets. The equity investment in these new and small firms is known as venture capital. The venture capitalists normally sit on the board of the startup firm, assist the management, and oversee the investment. After some period of time, the fund is liquidated and proceeds are distributed to the investors. Unlike venture capitalists, who focus on investing in startups, there are other investors who focus on firms in distress. They invest in distressed firms, improve their performance, and sell for profit. Thus, the investment in new startups and distressed firms that do not trade in stock exchanges by wealthy investors or limited partnership firms is known as private equity. Venture capital and private equity firms are yet to develop in Nepal.