Saturday, April 18, 2009

key services provided by the financial system (2)

No,one of greatest advantages of using the financial system to match individual savers and borrowers is that it allows the sharing of risks.
Rick refers to the chance that the value of financial assets will rise or fall relative to what you expect.For example,if you buy a bond of OKayco for $1000,that bond might be worth $900 or $1100 in one year,s time,depending on fluctuations in interest rates and OKayco ’s prospects.Most individual savers are not gamblers and seek a steady return on their assets rather than erratic swings between high and low earnings.The financial system provides (risk sharing by allowing savers to hold many assets.A collection of assets is called a portfolio.For example,you might hold some U.S. savings bonds,some shares of stocks,and some shares in a mutual fund.Although one asset or set of assets may perform well and anther not so well,overall the returns tend to average out.This splitting of wealth into many assets is know as "diversification".As long as the individual returns do not vary in the same way,the risk of severe fluctuations in a portfolio,s value will be markets can create instruments to transfer risk from savers or borrowers who do not like uncertainty in returns or payments to savers or investors who are willing to bear risk. For example,you might be willing to accept a lower return on your investment in your brother-in-law is business if he or one of his other investors guaranteed you that return.
the ability of the financial system to provide risk sharing makes savers more willing to buy borrowers’ IOUs. this willingness , in turn , increases borrowers’ ability to raise funds in the financial system .

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