Financial Markets and Institutions (2-downloads)

market makers. When an investor wishes to sell a thinly traded stock (one with-

out an active secondary market), it is unlikely that another investor is simultane-

ously seeking to buy that security. This nonsynchronous trading problem is solved

when the dealer buys the security from the investor and holds it in inventory until

another investor is ready to buy it. The knowledge that dealers will provide this ser-

vice encourages investors to buy securities that would be otherwise unaccept-

able. In countries with less well-developed financial markets, where dealers will not

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Part 6 The Financial Institutions Industry

make a market for less popular securities, it is extremely difficult for small, new,

or regional firms to raise funds. Securities market dealers are largely responsible

for the health and growth of small businesses in the United States.

Regulation of Securities Firms

Many financial firms engage in all three securities market activities, acting as brokers,

dealers, and investment bankers. The largest in the United States is Merrill Lynch;

other well-known firms include Morgan Stanley, and Salomon Smith Barney (a divi-

sion of Citigroup). The SEC not only regulates the firms’ investment banking oper-

ations but also restricts brokers and dealers from misrepresenting securities and from

trading on insider information, unpublicized facts known only to the management

of a corporation.

When discussing regulation, it is important to recognize that the public’s confi-

dence in the integrity of the financial markets is critical to the growth of our econ-

omy and the ability of firms to continue using the markets to raise new capital. If

the public believes that there are other powerful players with superior information

who can take advantage of smaller investors, the market will be unable to attract

funds from these smaller investors. Ultimately, the markets could fail entirely.

M I N I - C A S E