Financial martkets and institutions

Financial martkets and institutions

Assignment #1

What is the main function of financial markets? Who is usually better off in case of well-functioning markets? Explain your answer

The main function of financial markets is to provide a place for investors and companies to meet and support financial assets. It allows investors to buy and sell financial assets such as stocks, bonds and derivatives, at prices determined by supply and demand. Investors are best off because they are well informed about the market's performance without engaging in insider trading. They can make informed investment decisions based on current information. And because of this, they can buy assets at a reasonable price and sell them at a higher price to create their capital gains. But the financial market is very volatile and uncertain and this can lead to big losses for investors.

Explain the problem of adverse selection created by asymmetric flow of information. Use an example to illustrate your answer

Adverse selection can cause problems because it means that some people have more information about a financial asset than others. That is, it refers to a market situation where buyers or sellers have more information about a product or service than others. This can lead to investors with less information making riskier investment decisions.

For example, if an investor knows that a company is going to report poor results, he may sell his shares before this is known to the public, while investors who do not have this information may suffer losses. They will then be guided to do the opposite of what they were originally looking for. In fact, under conditions of uncertainty, buyers are forced to demand an average price, lower than what is offered, which will lead sellers to pull back and increase the bidding for inferior quality, further fueling distrust until any market transaction. In the case of asymmetric information on product quality, prices no longer play their signaling role properly.

How does the presence of asymmetric information in the direct selling market lead to consumers not buying the products?

The presence of asymmetric information in the direct selling market may lead consumers not to buy products because they are not sure of their quality or value. For example, if a car buyer will always be in uncertainty about its quality or efficiency of the car, this may discourage them from buying. This can lead to the creation of scams until creating a lack of confidence in the market.

How do financial intermediaries solve the problem of adverse selection?

Financial intermediaries can solve the problem of adverse selection by providing real information and analysis about financial assets to investors. An investor or a neutral institution in the market could provide real information about the price and quality of the asset. This will help investors make good investment decisions. They will be more enlightened and informed.

What is the main purpose of financial regulation? What kind of instruments may a government use to protect the economy and country from financial panic?