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ECS3701 ASSIGNMENT 2 2023 (SEMESTER 2) DUE DATE: 22 September 2023 (Complete Solutions)
ECS3701 Assignment 02 Semester 02 2023 Complete Answers for all Questions 2.01 to 2.05. All answers have been completed in accordance with the corresponding questions and should be used as guidelines.
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QUESTIONS
2.01 Explain how financial intermediaries reduce transaction costs thereby allowing small savers and borrowers to benefit from the existence of financial markets. [10]
ANSWER:
Financial intermediaries play a critical role in reducing transaction costs in financial markets, which, in turn, allows small savers and borrowers to benefit from the existence of these markets. Transaction costs are the expenses incurred when buying or selling financial assets, and they include fees, commissions, and other costs associated with trading. Here’s how financial intermediaries achieve this reduction in transaction costs:
1. Economies of Scale: Financial intermediaries pool funds from a large number of small savers. This aggregation of funds allows them to achieve economies of scale. They can invest in a diverse portfolio of assets, including stocks, bonds, and loans, which would be difficult for individual small savers to achieve cost-effectively. This diversification helps spread risk and reduce transaction costs because it’s less expensive for one institution to manage a large portfolio than for many individuals to manage small, fragmented portfolios.
2. Expertise and Information: Financial intermediaries have professional expertise and access to research and information that individual savers often lack. Their knowledge and resources enable them to make informed investment decisions, reducing the risk of poor investment choices. Small savers can benefit from this expertise without incurring the costs associated with acquiring such knowledge on their own.
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