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Role Of The Us Financial System

1081 words - 5 pages

Role of the US Financial System
As a company starts to expand and grow, a need to raise both short-term and long-term capital exists. This becomes one of the most basic business activities. Components of the US Financial System are the US Financial markets, investment bankers and capital sources, both short-term and long-term. Some major players in financial markets are brokers, dealers, financial intermediaries and investment bankers. Trahant (2007) stated that the US financial system is facing a crisis that rivals a natural disaster. He stated that “what we need is a miracle of balance: Enough financial penalties for those who gave or accepted risky loans – and at the same time enough ...view middle of the document...

Investment banks are financial intermediaries that merchandise stocks and bonds. Three components of an investment bank’s function exist between them and a company trying to raise funds and the investors who are buying the securities. Those components are origination, distribution and underwriting (Higgins, 2007, p. 38). Origination involves consulting with the company raising funds. This involves discussing the characteristics of the issuance and the underlying documents, the market conditions and advising the company when to bring the issuance to market and the pricing of that issuance. (Higgins, pp. 38-39). Underwriting involves the purchasing of a block of securities or all the securities issued by the company that is a client of the investment banker. By underwriting, the company does not assume the price or marketability risks of the issuance (Higgins, 2007, p. 39). Distribution refers to the security sale to the investor by the investment bank (Higgins, 2007, p. 40).
Sources of Capital
Several ways of raising capital are available to companies. Those sources are venture capital, reinvestment, bank loans, bonds and stocks (SIFMA, 2007). Venture capital, reinvestment and bank loans are short-term sources of capital. Stocks and bonds are long-term sources of capital. With venture capital the cost to a company is giving up a share of equity and control. The cost to a company with reinvestment is lost profits. The cost to a company with bank loans is paying interest. The cost to a company with bonds is paying interest. Stocks do not have a cost to the company unless a dividend is declared (SIFMA, 2007). Varying amounts of capital are available to a company on these different sources of capital. The amount of capital available through venture capital varies as it comes from a pool of money from investors who are willing to take risks on a new business. Through reinvestment the amount of capital available is the profits that can be earned. The amount of capital available from a bank loan is determined by the bank which is from their evaluation of a company’s ability to pay back the loan. The capital available through bonds is determined by a company’s ability to offer competitive interest rates. The available capital through stocks is determined by supply and demand (SIFMA, 2007).
Sometimes companies may face short-term and temporary cash needs. Short-term financing is used to meet the temporary cash...

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