Households can deposit their surplus funds with banks, or buy the shares and debentures offered by a business. The process by which this allocation of funds is done is called ______.
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → financial intermediation
Option (1) price discovery — Incorrect. Price discovery is the setting of the price of a financial asset through the interaction of households, who supply funds, and firms, who demand them. It is about the price of an asset.
Option (2) financial intermediation — Correct. Funds can reach business firms in two ways: through banks, or through shares and debentures bought in financial markets. This allocation of funds through banks and markets is called financial intermediation.
Option (3) providing liquidity — Incorrect. Providing liquidity means financial assets can be easily converted into cash, because they are easy to buy and sell. It is about turning assets into cash.
Option (4) reducing the cost of transactions — Incorrect. Reducing the cost of transactions means the market saves the time, effort and money buyers and sellers spend to find each other. It is about saving cost for buyers and sellers.
NCERT (Pre-rationalised Edition): “CONCEPT OF FINANCIAL MARKET … There are two major alternative mechanisms through which allocation of funds can be done: via banks or via financial markets. Households can deposit their surplus funds with banks, who in turn could lend these funds to business firms. Alternately, households can buy the shares and debentures offered by a business using financial markets. The process by which allocation of funds is done is called financial intermediation. Banks and financial markets are competing intermediaries in the financial system, and give households a choice of where they want to place their savings. …” |