An Intermediary’s Guide to Finance

Besides private banking, wholesale finance encompasses all forms of fund-management and inter-institutional trade. This sector employs “quants” and has diverse sub-disciplines, including personal finance, public finance, and corporate finance. The key topics in wholesale finance are risk management and regulatory capital. While wholesale finance is a vast subject, it is also a growing industry. This article will provide an overview of wholesale finance and its different sub-disciplines.

Intermediaries

In the field of finance, intermediaries play an important role. They provide services to the end users, like investors and depositors, and provide a platform for the latter to purchase those products. Intermediaries are essential to the growth of globalism, as they make the transition from user to product or service easier and more efficient. But their role is not without flaws. Here are some examples of how they may add value to the industry.

The main purpose of intermediaries is to bridge the gap between the two parties. One example of an intermediary is a retailer. It acts as a bridge between a brand and a customer. Walmart, for example, acts as a middleman between the two. This type of intermediary is essential to the success of many businesses and their consumers. However, these intermediaries do have costs. If you want to save money, it may be a good idea to look for companies that can pass those savings on to the consumer.

Heterogeneity in financial markets

Financial markets have long exhibited heterogeneity, but this phenomenon is particularly striking. While the same observable characteristics explain one-third of the variation in returns, adding heterogeneous investors to the equation leads to two-thirds, four-fifths, and even 80% of the variance. Investors’ behavior and the distribution of information are endogenous, with their positions based on information that they cannot control, not just their own intentions. This endogenous information impacts capital flows, asset allocation, and the connectivity of assets.

To understand the nature of heterogeneity in financial markets, one must first define what it means. For instance, in the CAC40, five stocks may represent healthcare, energy, financial services, and consumer defensive sectors. These stocks may not be representative of the entire CAC40, but they may reproduce the same structure. As long as the CAC40 represents each of these sectors, it is likely that these five stocks reflect a wide variety of economic activity.

Modigliani-Miller theorem

A well-known example of the Modigliani-Miller theorum in finance is a baseball catcher named Yogi Berra. The legendary baseball player once told his trainer to cut a pizza into twelve pieces. The baseball trainer, referring to his catching ability, was demonstrating a basic lesson in finance. The baseball player was referring to the Modigliani-Miller theorem, which states that the value of a firm does not depend on its capital structure.

The Modigliani-Miller theorists began to challenge this basic premise in 1958. Their research included a model that assumed investors and companies could borrow at the same price. The model argued that, if a firm can borrow at the same cost as an investor, the end result will be the same, regardless of the source of the funds. However, if firms and investors were able to borrow at different rates, the Modigliani-Miller theorem would no longer hold.

Modigliani-Miller effect

The Modigliani-Miller effect in the theory of corporate finance describes that the amount of debt a firm has is directly proportional to its enterprise value. As debt levels rise, so does the probability of default, and investors demand higher returns for investments with increased risk. In this way, the valuation of a levered company is greater than that of a lean, unsecured firm. This is not to say that all leveraged companies have higher valuations, but a combination of factors, including the asymmetric information and bankruptcy costs.

Depending on the type of financing a firm receives, it can have three ways to raise money: issuing new stock to investors, obtaining loans, or reinvesting profits. The Modigliani-Miller effect suggests that the choice of which option a firm chooses does not affect its real market value. This is because the market value of the firm depends primarily on the present value of its future earnings and the costs of the capital structure. However, this theorem only holds if underlying assumptions are true.