CHAPTER 1

Financial intermediation refers to the process by which institutions act as middlemen between
parties with surplus funds (savers) and those who need funds (borrowers). These institutions
channel funds from savers to borrowers,
Role of FIs

 Transforming Assets and Liabilities: Financial intermediaries take deposits

from lenders and use them to provide loans and other financial products to
borrowers. In essence, they transform the lender's low-risk, less liquid assets
(deposits) into higher-risk, less liquid assets (loans) for borrowers. This
transformation allows lenders to earn a return on their savings, while borrowers
gain access to funds for various purposes.

 Moral Hazard: This arises when borrowers act less cautiously because they
believe the financial intermediary will bail them out if they default on a loan.
Financial intermediaries try to mitigate this by carefully assessing
creditworthiness and setting loan terms that incentivize responsible borrowing.

 Portfolio Creation: Financial intermediaries like banks and investment firms

assist individuals in building investment portfolios.

 Easing Liquidity Constraints: Financial intermediaries help address liquidity

constraints by providing savers with easy access to their deposited funds, while
offering borrowers long-term financing for projects or purchases. This ensures a
balance between immediate needs and long-term financial goals.

Short selling occurs when an investor borrows a security and sells it on the
open market, planning to buy it back later for less money.

 Borrow and Sell: An investor borrows shares of a security they believe will go
down in price from a broker.
 Sell High, Buy Low (Ideally): The investor then sells the borrowed shares on
the open market at a higher price (ideally).
 Repurchase and Return: Later, when the price drops (hopefully), the investor
repurchases the same number of shares at the lower price and returns them to
the broker.

Long selling
n investor buys that security or investment with the prospect of keeping it
for some time because he or she believes that its price (or value) is going
to increase in the long run.

Merchant banking is a specialized form of banking that focuses on

providing customized financial services and advice to corporations,
governments, and high net-worth individuals.