Our country's financial system consists of institutions that help facilitate the flow of funds from those who have funds to those who need funds to invest. Financing a home purchase by rounding up enough people willing to lend can be challenging and a little awkward, but it requires careful planning. At the same time, there is a lot of documentation and keeping track of loan agreements, how much and to whom should be repaid, whether the people borrowing from should repay the loan, what interest rate they should charge for the use of their funds, the financial system shows.
Financial systems enable the transfer of funds more efficiently by reducing the problem of information asymmetry between those who have funds to invest and those who need funds. Apart from lenders and borrowers, the financial system consists of three components:
- Financial markets (where transactions take place).
- Financial intermediaries (those who facilitate transactions).
- Regulators of economic activity (who try to make sure everyone is playing fair).
In this chapter we look at each of these factors and the motivation for their existence. Before we discuss participants we first need to discuss financial assets that represent loans or investments.
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