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Finance Questions and Answers

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1. A highly developed and efficient financial system is essential to ongoing economic

growth and prosperity. Discuss the component parts that form a financial system and the relevance of the above statement.

A financial system consists of financial institutions, financial instruments and financial markets. Financial institutions are classified into five categories according to where they source their funds from and who uses their funds. These include: depository financial institutions e.g. banks; investment and merchant banks; contractual savings institutions e.g. insurance companies; finance companies and general financiers; unit trusts e.g. property trusts. Financial instruments are documents that entitle holders to future cash flows. They are classified into three categories: equity e.g. ordinary share; debt e.g. loan; derivatives e.g. futures contract. Financial markets are the means by which funds are transferred in financial systems and are broadly divided into money markets and capital markets, which are further split into primary and secondary markets. Examples of financial markets include stock market and foreign exchange market.


The primary function of the financial system is to facilitate the flow of funds from those who have surplus funds to those who have a shortage of funds. By providing a range of investment and borrowing opportunities, the financial system supports transactions within economies thus providing the means for the development of modern economic systems. Economic growth is also reliant on the continuous restructuring of the economy which a well-developed financial system would support by efficient reallocation of savings and resources within domestic and international markets. Furthermore, highly…...

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