Additional Benefits FIs Provide to Suppliers of Funds

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Additional Benefits FIs Provide to Suppliers of Funds
The indirect investing of funds through financial institutions is attractive to fund suppliers for other reasons as well.We discuss these below and summarize them in Table 1–6

Reduced Transaction Cost. Not only do financial institutions have a greater incentive to collect information, but also their average cost of collecting relevant information is lower than for the individual investor (i.e., information collection enjoys economies of scale ). For example, the cost to a small investor of buying a $100 broker’s report may seem inordinately high for a $10,000 investment. For an FI with $10 billion of assets under management, however, the cost seems trivial. Such economies of scale of information production and collection tend to enhance the advantages to investors of investing via FIs rather than directly investing themselves

Nevertheless, as a result of technological advances, the costs of direct access to financial markets by savers are ever falling and the relative benefits to the individual savers of investing through FIs are narrowing. An example is the ability to reduce transactions costs with an etrade on the Internet rather than using a traditional stockbroker and paying brokerage fees (see Chapter 8 ). Another example is the private placement market, in which corporations such as General Electric sell securities directly to investors, often without using underwriters. In addition, a number of companies allow investors to buy their stock directly without using a broker. Among well-known companies that have instituted such stock purchase plans are AT&T, Microsoft, Marathon Oil, IBM, and Walt Disney Co.

Maturity Intermediation.

 An additional dimension of financial institutions’ ability to reduce risk by diversification is their greater ability, compared to a small saver, to bear the risk of mismatching the maturities of their assets and liabilities. Thus, FIs offer maturity intermediation services to the rest of the economy. Specifically, by maturity mismatching, FIs can produce new types of contracts such as long-term mortgage loans to households, while still raising funds with short-term liability contracts such as deposits.

Denomination Intermediation.

Some FIs, especially mutual funds, perform a unique service because they provide services relating to denomination intermediation. Because many assets are sold in very large denominations, they are either out of reach of individual savers or would result in savers holding very undiversified asset portfolios. For example, the minimum size of a negotiable CD is $100,000, while commercial paper (short-term corporate debt) is often sold in minimum packages of $250,000 or more. Individual small savers may be unable to purchase such instruments directly. However, by pooling the funds of many small savers (such as by buying shares in a mutual fund with other small investors), small savers overcome constraints to buying assets imposed by large minimum denomination size. Such indirect access to these markets may allow small savers to generate higher returns (and lower risks) on their portfolios as well.

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