FOREX AND FINANCIAL

INSTITUTIONS
 FOREIGN EXCHANGE MARKET
• For funds to be transferred from one country to
another they have to be converted from the currency in
the country of origin (say BWP) to the currency of the
country they are going to (say EUROS).
• The foreign exchange market is where this conversion
takes place so it is instrumental in moving funds
between countries.
• It is also important because it is where the foreign
exchange rate, the price of one currency in terms of
another is determined.
• Direct quote?
• Indirect quote?
 FOREIGN EXCHANGE REGIMES
1.Fixed Exchange Rate Regime
• It is an exchange rate regime where the exchange rate is
set and fixed at a particular rate by the central bank.
2. Floating Exchange Rate Regime
• An exchange rate regime where the exchange rate is
determined by forces of demand and supply.
3. Managed Float Exchange Rate Regime
• An exchange rate regime where the exchange rate is
primarily determined by forces of demand and supply and
the government intervenes in the market whenever there
is a disequilibrium i.e. when the exchange rate fluctuates
outside a set band/parameter.
 FOREIGN EXCHANGE RATES
• There are predominantly two kinds of exchange
rates transactions;
• The spot transactions; which involves the
immediate (two-day) exchange of bank deposits.
• Forward transactions; involving the exchange
of bank deposits at some specified future date.
• When a currency increases in value it
experiences appreciation.
• When it falls in value in undergoes depreciation.
 HOW IS FOREX TRADED
• Exchange rates are not determined at some centralized
location nor are they traded on exchanges such as the New
York Stock Exchange.
• The foreign exchange market is organised as an over-the
counter market in which several hundred dealers (mostly
banks) stand ready to buy and sell deposits denominated in
foreign currencies.
• Since these dealers are in constant telephone and computer
contact, the market is very competitive.
• An important point to note is that although banks, companies
and governments talk about buying and selling currencies in
foreign exchange markets, they do not take a fistful of dollar
bills and sell them for British Pound notes.
 HOW IS FOREX TRADED
• Most trades rather involve the buying and selling of
bank deposits denominated in different currencies.
• So when we say a bank is buying dollars in the
foreign exchange market, what we actually mean is
that the bank is buying deposits denominated in
dollars.
• Individuals buy foreign currency in the retail market
from dealers such as American express or from
banks.
EXCHANGE RATES IN THE LONG RUN

LAW OF ONE PRICE

• If two countries produce an identical
good and transportation costs and
trade barriers are very low, the price of
the good should be the same
throughout the world no matter which
country produces it.
 LAW OF ONE PRICE

• Hypothetical Example: Botswana steel

costs P100 per ton, while South Africa
steel costs
If E-rate = 50R10,
Rand000
/Pulaper
thenton.
price are:
Botswana Steel RSA Steel
In Bots P100 P200
In RSA R5000 R10,000

If E-rate = 100 Rand/Pula then price are:

Botswana Steel RSA Steel
In Bots P100 P100
In RSA R10,000 R10,000
 LAW OF ONE PRICE
 E-rate = 100 Rand/Pula
Class Quiz:
 Recently the rand price of South Africa steel has
increased by 10% to (11,000 rand) relative to the
pula price of Botswana steel (unchanged at
P100).
 By what amount must the pula increase or
decrease in value for the law of one price to
hold? Explain.
 EXCHANGE RATES IN THE LONG RUN
THEORY OF PURCHASING POWER PARITY
• The theory states that exchange rates between any two
currencies will adjust to reflect changes in the price
levels of the two countries.
• The law is simply the application of the Law Of One Price
to national price levels rather than to individual prices.
• For the law of one price to hold, the exchange rate must
rise to 110R to the BWP, a 10% appreciation of the Pula.
• Applying the law of one price to the price levels in the
two countries produces the theory of purchasing power
theory, which maintains that if the RSA price level rises
10% relative to the BWP price level, the Pula will
appreciate 10%.
 EXCHANGE RATES IN THE LONG RUN
• Another way of thinking about this theory is through a concept
known as the real exchange rate, the rate at which domestic
goods can be exchanged for foreign goods.
• The price of domestic goods relative to the price of foreign goods
denominated in domestic currency.
• For example if a basket of goods in Gaborone costs P50 while
the same basket of goods in Johannesburg costs P75 because it
costs R7500 while the exchange rate is 100R per Pula, then the
real exchange rate is P50/P75= 0.66.
• The real exchange rate is below 1.0 indicating that it is cheaper to
buy the basket of goods in the Botswana than in South Africa.
• Another way of looking at PPP is to say that it predicts that the
real exchange rate is always equal to 1.0, so that the purchasing
power of the BWP is the same as that of other currencies such as
the Rand or the Kenyan Shillings.
EXCHANGE RATES IN THE LONG RUN

• Our Botswana/RSA example demonstrates that

the PPP suggests that if one country’s price
level rises relative to another’s its currency
should depreciate (the other country’s currency
should appreciate).
• However this prediction is borne out in the long
run, it is not perfect in the short run.
 WHY PPP CANNOT FULLY EXPLAIN
EXCHANGE RATES
• Remembers the assumptions of the Theory of Purchasing Power
Parity:
– All goods are identical in both countries
– Trade barriers and transportation costs are low
• These assumptions may not be true for some products.
• For example, American cars and Japanese cars are not
necessarily the same; Is a Toyota the equivalent of a Chevrolet?
• Should Toyotas become more expensive than Chevs and be
bought by citizens of both Japan and America, it is not a given
that the Yen will naturally depreciate by the amount of the relative
price increase as predicted by the theory.
• Furthermore, the PPP does not take into account that many goods
and services (whose prices are included in a measure of a
country’s price level) are not traded across borders(haircuts, land
etc)
 EXCHANGE RATES IN THE LONG
RUN
• The basic reasoning proceeds as follows;
• Anything that increases the demand for domestically
produced goods that are traded relative to foreign traded
goods tends to appreciate the domestic currency.
• Similarly anything that increases the demand for foreign
goods relative to domestic goods tends to depreciate the
domestic currency.
• In other words; if a factor increases the demand for domestic
goods relative to foreign goods, the domestic currency will
appreciate, if a factor decreases the relative demand for
domestic goods, the domestic currency will depreciate.
 EXCHANGE RATES IN THE LONG
RUN
FACTORS AFFECTING EXCHANGE
RATES IN THE LONG RUN
• Four major factors affect the exchange
rate;
• Relative price levels
• Trade barriers
• Preferences for domestic goods versus
foreign goods
• Productivity
 EXCHANGE RATES IN THE LONG
RUN
Relative price levels
• In line with the PPP, when prices of American
goods rise, their demand will fall and the dollar will
depreciate so that American goods can sell well.
• By contrast, if it is Japanese prices that rise, the
demand for American goods will still increase and
the dollar tends to appreciate.
• In the long run, a rise in a country’s price level
(relative to foreign price level) causes its currency
to depreciate and a fall in the country’s relative
price level causes its currency to appreciate.
 EXCHANGE RATES IN THE LONG RUN
Trade Barriers
• Barriers to trade such as tariffs and quotas can
affect the exchange rate.
• Suppose that Botswana increases tariffs or puts
a lower quota on Zambian copper.
• These increases in trade barriers increases the
demand for Botswana copper and the Pula
tends to appreciate.
• Increasing trade barriers causes a country’s
currency to appreciate in the long run.
 EXCHANGE RATES IN THE LONG RUN
Preferences for Domestic Versus Foreign Goods
• If the Japanese develop an appetite for American goods,
say Oranges and movies, the increased demand for
American goods tends to appreciate the dollar.
• If Americans decide that they prefer Japanese cars to
American cars, the increased demand for Japanese
goods tends to depreciate the dollar.
• Increased demand for a country’s exports causes its
currency to appreciate in the long run, but increased
demand for imports causes the domestic currency to
depreciate.
 EXCHANGE RATES IN THE LONG RUN
Productivity
• With an increase in a country’s productivity there is a tendency
for sectors producing traded goods to experience an increase
in productivity than those producing the non-traded ones.
• Since higher productivity is associated with a decline in the
price of domestically produced traded goods, the demand for
these goods will rise and the domestic currency tends to
appreciate.
• With a lag in productivity, a country’s traded goods become
relatively more expensive and the currency tends to depreciate.
• In the long run, as a country becomes more productive relative
to other countries, its currency appreciates.
SUMMARY FOR THE ABOVE FACTORS
 EXCHANGE RATES IN THE SHORT RUN: A
SUPPLY AND DEMAND ANALYSIS
• The key to understanding the short-run behaviour
of exchange rates is to recognise that an
exchange rate is the price of domestic assets
(bank deposits bonds, equities and so on,
denominated in domestic currency) in terms of
foreign assets (similar assets denominated in
foreign currency).
• Use of the demand and supply analysis that
heavily relies on the theory of portfolio choice.
 EXCHANGE RATES IN THE SHORT RUN: A
SUPPLY AND DEMAND ANALYSIS
Supply Curve for Domestic Assets
• In this analysis we treat the USA as the home
country so domestic assets are denominated in
dollars.
• For simplicity we use Euros to stand for any foreign
currency, so foreign assets are denominated in
Euros
• Quantity of dollar assets supplied is primarily the
quantity of bank deposits, bonds and equities in the
USA and for all practical purposes we can take this
amount fixed with respect to the exchange rate.
 EXCHANGE RATES IN THE SHORT RUN: A
SUPPLY AND DEMAND ANALYSIS
Demand curve for Domestic Assets
• Traces the quantity demanded at each current exchange
rate by holding everything else constant, particularly the
expected future value of the exchange rate.
• Denote Et, the current exchange rate (spot exchange
rate) and Et+1, the expected exchange rate for the next
period.
• As predicted by the theory of portfolio choice the most
important determinant of the quantity of domestic dollar
assets demanded is the relative expected return of
domestic assets.
• What happens when Et falls?
 EXCHANGE RATES IN THE SHORT RUN: A
SUPPLY AND DEMAND ANALYSIS
• Suppose we start at point A in the figure, where the
current exchange rate is EA, with the future expected
value of the exchange rate held constant at E t+1,a
lower value of the exchange rate say E*,implies that
the dollar is more likely to rise in value, appreciate.
• The greater the expected rise(appreciation) of the
dollar, the higher is the relative expected return on
dollar (domestic) assets
• According to the theory of the portfolio choice if dolllar
assets are more desirable to hold , the quantity of
dollar assets demanded will rise as shown by point B.
 EXCHANGE RATES IN THE SHORT RUN: A
SUPPLY AND DEMAND ANALYSIS
• If the currency exchange rate falls even further to
EC, there is an even higher expected appreciation of
the dollar, the higher expected return, and therefore
an even greater quantity of dollar assets
demanded.
• This effect is shown at point C in the figure.
• The resulting demand curve, D, which connects
these points, is downward sloping ,indicating that at
lower current values of the dollar, ceteris paribus,
the quantity demanded of dollar assets is higher.
 EXCHANGE RATES IN THE SHORT RUN: A
SUPPLY AND DEMAND ANALYSIS
EQUILIBRIUM IN THE FOREIGN EXCHANGE MARKET
• As in the usual supply and demand analysis, the market
is in equilibrium when the quantity of dollar assets
demanded equals the quantity supplied.
• This occurs at point B in the diagram where the
exchange rate is E*.
• Suppose that the exchange rate is at EA, where we have
a condition of excess supply. The dollar will therefore fall
in value until it reaches the equilibrium exchange rate.
• Similarly if the exchange rate is lower than the
equilibrium exchange rate, we have a condition of
excess demand. The value of the dollar will rise until the
excess demand disappears.
 EXCHANGE RATES IN THE SHORT RUN: A
SUPPLY AND DEMAND ANALYSIS
• EQUILIBRIUM IN THE FOREIGN EXCHANGE
MARKET
 EXPLAINING CHANGES IN EXCHANGE RATES
SHIFTS IN THE DEMAND FOR DOMESTIC ASSETS
• For insights into the direction of the shift of the demand
curve, suppose you are an investor considering putting
away funds into domestic (dollar) assets.
• When a factor changes decide whether at a given level
of the current exchange rate, holding all other variables
constant, you would earn a higher or lower expected
return on dollar assets versus foreign assets.
• The decision tells you whether you want to hold more or
fewer dollar assets and whether the quantity demanded
increases or decreases at each level of the exchange
rate.
 SHIFTS IN THE DEMAND FOR DOMESTIC ASSETS
Domestic Interest Rate
• When the domestic interest rate on dollar assets, iD
rises holding the current exchange rate Et constant,
the return on dollar assets increases relative to foreign
assets, so people will want to hold more dollar assets.
• The quantity of dollar assets demanded increases at
every value of the exchange rate.
• Shifting the demand curve to the right.
• An increases in the domestic interest rate shifts the
demand curve for domestic assets to the right,
causing the domestic currency to appreciate.
• Conversely, a decrease in the domestic interest rate,
shifts the demand curve to the left and causes the
domestic currency to depreciate.
SHIFTS IN THE DEMAND FOR DOMESTIC
ASSETS
 SHIFTS IN THE DEMAND FOR DOMESTIC ASSETS
Foreign Interest rate
• When the foreign interest rate, iF rises, holding the current
exchange rate and everything else constant, the return on
foreign assets rises relative to dollar assets rises.
• People would want to hold fewer dollar assets and the
quantity demanded declines at every value of the
exchange rate.
• This leads to a leftward shift of the demand curve and the
value of the dollar will fall.
• Conversely a decrease in iF, raises the relative expected
return on dollar assets, shifting the demand curve to the
right, raising the exchange rate.
SHIFTS IN THE DEMAND FOR DOMESTIC
ASSETS
 SHIFTS IN THE DEMAND FOR
DOMESTIC ASSETS
Changes in the Expected future exchange rate
• Any factor that causes the expected future
exchange rate, Eet+1,to rise increases the
expected appreciation of the dollar.
• The result is a higher relative expected return
on dollar assets, which increases the demand
for dollar assets at every exchange rate,
thereby shifting the demand curve to the right.
• A fall in Eet+1 shifts the demand curve to the left
and causes a depreciation of the currency.
SHIFTS IN THE DEMAND FOR DOMESTIC
ASSETS
 SHIFTS IN THE DEMAND FOR DOMESTIC
ASSETS
• The relative price level, relative trade barriers, import
and export demand and relative productivity influence
the relative future expected exchange rate.
• The PPP suggests that If a higher American price level
relative to a foreign price level is expected to persist, the
dollar will depreciate in the long run.
• A higher expected relative American price level should
thus have the tendency to lower Eet+1,lower the relative
expected return on dollar assets, shift the demand curve
to the left and then lower the current exchange rate.
 SHIFTS IN THE DEMAND FOR DOMESTIC
ASSETS
• Similarly, the long run determinants of the exchange
rate can influence the relative expected return on
dollar assets and the current exchange rate.
• All of the following will raise Eet+1 by increasing the demand
for domestic goods relative to foreign goods;
o Expectations of a fall in the American Price levels relative to the foreign
price level.
o Expectations of higher American trade barriers relative to
to foreign trade barriers.
o Expectations of lower American import demand
o Expectations of higher foreign demand for American exports
o Expectations of higher American productivity relative to foreign
productivity.
 SUMMARY
• Factors That Shift the Demand Curve for
Domestic Assets and Affect the Exchange
Rate
• See page 435
 FINANCIAL INSTITUTIONS
• These are institutions whose primary objective is to facilitate
investment by channelling funds from surplus units (Lender-savers) to
the deficit units (borrower-spenders) of the economy.
• Financial systems consist of Financial Intermediaries and Financial
Markets.
Financial Markets
• They facilitate the trade of financial instruments where
deficit units “firms” sell financial instruments to surplus units
“Investors” from which the investors claim on the firms’
future income and/or assets.
• This is referred to as Direct Finance.
• They consist of the stock exchange, Brokers, Dealers, Fund
Managers, etc.
 IMPORTANCE OF FINANCIAL MARKETS
 They allow funds to move from people who lack productive
investment opportunities to people who have them.
 Financial markets are critical for producing an efficient
allocation of capital(wealth that is employed to produce more
wealth).
 Financial markets also improve the well-being of consumers,
allowing them to time their purchases better.
 STRUCTURE OF FINANCIAL MARKETS
Debt and equity markets
• One can obtain funds in two ways, the most common method
is to issue a debt instrument such as a bond or a mortgage
which is a contractual agreement by the borrower to pay the
holder of the instrument a fixed amount over a certain period
of time.
• The maturity of a debt instrument is the number of years until
the instrument’s expiration date. A debt instrument is short-
term if its maturity is less than a year, and long-term if it is
more than 10 years. 1 – 10 year debt instruments are said to be
intermediate-term instruments.
• raising funds is by issuing equities, such as common stock,
which are claims to share in the net income and assets of a
business
 STRUCTURE OF FINANCIAL MARKETS
Primary and Secondary Markets
• A primary market is a financial market in which new issues of a
security, such as a bond or stock, are sold to initial buyers by the
corporation borrowing the funds. A secondary market is a financial
market in which securities that have previously been issued can be
resold.
• Primary markets for securities are not well known to the public.
• An important financial institution that assists in the initial sale of
securities in the primary market is the investment bank. It does this
by underwriting securities, it guarantees a price for corporation’s
securities and then sells them to the public. Examples include; stock
exchanges, forex markets, futures markets and options markets.
• Brokers are agents of investors who match buyers with sellers of
securities, dealer’s link buyers and sellers by buying and selling
securities as stated prices.
 STRUCTURE OF FINANCIAL MARKETS
Exchanges and Over-the-Counter Markets
Secondary markets can be organized in two ways;
• One method is to organize exchanges where buyers
and sellers meet in one central location to conduct
trades. Eg New York stock exchange
• The other method is to have an over-the-counter
(OTC) market, in which dealers at different locations
who have an inventory of securities stand ready to
buy and sell securities over the counter to anyone
who is willing to accept the prices.
 STRUCTURE OF FINANCIAL MARKETS
• The money market is a financial market in which
only short-term debt instruments are traded.
• They are more widely traded and so tend to be
more liquid. Short term instruments also have
smaller fluctuations making them safer
instruments.
• The capital markets is the market is the market in
which longer-term debt and equity instruments
are traded.
 INTERNATIONALISATION OF FINANCIAL
MARKETS
 International Bond Market & Eurobonds
─ Foreign bonds
• Sold in a foreign country and denominated in that country’s currency
─ Eurobonds
• denominated in a currency other than of the country in which it is sold
• now larger than U.S. corporate bond market
• Over 80% of new bonds are Eurobonds.
 Eurocurrency Market
─ Foreign currencies deposited in banks outside of home country
─ Most important -Eurodollars are U.S. dollars deposited, say,
London.
─ Gives U.S. borrows an alternative source for dollars.
 World Stock Markets
─ U.S. stock markets are no longer always the largest—at one point,
Japan’s was larger
 FINANCIAL INTERMEDIARIES
• Funds move from lenders to borrowers through two routes;
• Direct finance, where borrowers borrow funds directly from
lenders in financial markets by selling the securities which are
claims on the borrowers future income or assets.
• Securities are assets for the person who buys them but liabilities
for the individual or firms that sells/issues them.
• Indirect Finance involves a financial intermediary that stands
between the lender-savers and the borrower-spenders and helps
transfer funds from one to the other.
• A financial intermediary does this by borrowing funds from the
lender-savers and then using these funds to make loans to the
borrower-spenders.
 FINANCIAL INTERMEDIARIES
• For example a bank might acquire funds by
issuing a liability to the public (an asset for the
public) in the form of savings deposits
• It might then use the funds to acquire an asset
by making a loan to Barloworld Motor or by
buying BOBC in the financial markets.
• The ultimate result is that funds have been
transferred from the public to Barloworld Motor
with the help of the financial intermediary.
FINANCIAL INTERMEDIARIES
 FINANCIAL INTERMEDIARIES
• The process of indirect finance using financial
intermediaries called Financial intermediation,
is the primary route for moving funds from
lenders to borrowers.
• Why are financial intermediaries and indirect
finance important in financial markets?
• To answer this question we need to understand
the role of transaction costs, risk sharing and
information costs in financial markets.
 FINANCIAL INTERMEDIARIES
• Transaction Costs - Are the time and money spent in carrying
out financial transactions. Financial intermediaries reduce the
transaction costs as they have the expertise and can take
advantage of economies of scale. The low cost allows financial
intermediaries to provide customers with liquid services, i.e.
services that make it easier to conduct transactions.
• Risk Sharing – Financial intermediaries create and sell assets
with risk characteristics that people are comfortable with. Low
transactions allow for risk to be shared at low cost, enabling
profit to be earned on the spread between returns. Risk
sharing is also known as asset transformation as they are
turned into safer assets. Diversification entails investing in a
collection of assets with the result that risk is lower than a
single asset.
 FINANCIAL INTERMEDIARIES
• Asymmetrical Information: Adverse selection and Moral Hazard
Lack of information creates problems on two fronts:
– Adverse Selection – created by asymmetric selection before the
transaction occurs. It occurs when the potential borrows who are most
likely to produce an undesirable outcome (bad credit risks) are the ones
who most actively seek out loans and thus are likely to be selected causing
lenders not to make any loans.
– Moral Hazard - created by asymmetric selection after the transaction
occurs. It is the risk (hazard) that the borrower might engage in
activities that are undesirable (immoral) from a lenders point of view,
because they make it less likely that the loan will be paid back.
Financial intermediaries are better equipped than individuals to screen
out the bad credit risks from the good ones reducing the losses
resulting from adverse selection.
 FINANCIAL INTERMEDIARIES
• Economies of Scope and Conflicts of interest –
Financial intermediaries provide multiple financial
services achieving economies of scope, i.e. they can
lower the cost of information production for each
service by applying one information resource to may
different services. This can also cause conflicts of
interest in that a person or institution has multiple
objectives and may have a conflict between the
objectives. The competing interest of the services may
lead to an individual or firm to conceal or disseminate
misleading information.
 FINANCIAL INTERMEDIARIES
• To conclude: Financial intermediaries play an
important role in that they:
• Provide liquidity services
• Promote risk sharing
• Solve information problems
• Channel funds from lender-savers to
borrower-spenders.
 TYPES OF FINANCIAL INTERMEDIARIES
Financial intermediaries fall into three categories:
• Depository institutions
• Contractual saving institutions
• Investment intermediaries
Depository institutions
• Also referred to as banks that accept deposits from
individuals and companies and then make loans. They are
involved in the creation of deposits. These include
commercial banks and thrift institutions (thrifts); savings and
loan associations, mutual savings banks and credit unions.
 TYPES OF FINANCIAL INTERMEDIARIES
• Commercial banks – Financial intermediaries that raise fund
by issuing checkable deposits, savings deposits and time
deposits and use these funds to make loans.
• Savings and loan associations (S & L’s) and Mutual Savings
Banks – Obtain funds through savings deposits, time and
checkable deposits and were restricted and mostly made
residential mortgage loans, this has changed/loosened
recently.
• Credit Unions – Typically very small cooperative lending
institutions organized around a particular group. They acquire
funds from deposits called shares and primarily make
consumer loans.
 TYPES OF FINANCIAL INTERMEDIARIES
Contractual Saving Institutions
• These are insurance companies and pension funds that
acquire funds at periodic intervals on a contractual basis.
They can predict how much they will have to pay out they
do not worry as much as depository institutions. Liquidity
of assets is not important and mostly invests in long-term
securities such as corporate bonds.
• Life Insurance Companies – Insure people against
financial hazards following a death and sell annuities.
They acquire funds from premiums and used mainly to
buy corporate bonds and mortgages.
 TYPES OF FINANCIAL INTERMEDIARIES
• Fire and Casualty Insurance companies – Insure
their policyholders against fire, theft and
accidents. Acquire funds through premiums and
buy more liquid securities such as municipal
bonds.
• Pension Funds and Government Retirement
Funds – Provide retirement income in the form of
annuities to covered employees. Funds are
acquired by employees and employers. The largest
assets are corporate bonds and stocks.
 TYPES OF FINANCIAL INTERMEDIARIES
Investment Intermediaries
– Finance companies – Raise funds by selling commercial
paper (short-term debt instrument) and by issuing
stocks and bonds. They lend funds to consumers to buy
furniture, cars and home improvements
– Mutual Funds – Acquire funds by selling shares to many
individuals and use the proceeds to purchase diversified
portfolios of stocks and bonds. They allow shareholders
to pool funds to take advantage of lower transaction
costs. And allow for more diversified portfolios.
 TYPES OF FINANCIAL INTERMEDIARIES
• Money Market Mutual Funds – They sells shares to
acquire funds and use the funds to by money market
instruments that are both safe and liquid. The interest on
the assets is paid to shareholders. Shareholder scan write
checks against the value of their shareholdings.
• Investment Banks – An intermediary that helps
corporations issue securities. It advises which type of
securities to issue (stocks or bonds) and then helps sell or
underwrite the securities by buying them at a
predetermined price and selling them to the market. They
also act as deal makers through mergers and acquisitions.
 TYPES OF FINANCIAL INTERMEDIARIES
• Hedge Funds; A type of mutual fund with
special features. They are organised as limited
partnerships. Hedge funds invest in many
types of assets with some specialising in stock,
others in bonds others in foreign currency.
 OPERATION OF BANKS
The functions of commercial banks include the following;
1. The primary role is to accept deposits and give out
loans
Commercial banks accept deposits from surplus units
and give out loans to deficit units in the economy.
2. The creation of money
They create a type of money by accepting demand
deposits on which people can write cheques. Demand
deposits are in some cases a very important form of
money compared to currency (paper money and coins).
 OPERATION OF BANKS
3. They assist in the distribution of currency throughout the
economy
This is done through the branch system and Automatic Teller
Machines (ATMs). Notes and coins deposited into branches in one
region can be withdrawn through branches in other regions or part
of the country.
4. They conduct foreign exchange transactions on behalf of
customers
Banks are involved in the process of buying and selling of foreign
currency for their clients. For example, if a customer wants to
purchase goods overseas they need foreign exchange and banks
assist in the acquisition of foreign exchange.
 OPERATION OF BANKS
5. Provide Financial Advise to the general
public
Banks have a mandate to provide financial
information to the general public through
various fora. They organize workshops and
seminars where they educate the general public
on finance and economics. This is part of their
Corporate Social responsibility.
• THE END