Managing Retail Investment Portfolio

How an individual can Manage Investment Portfolio

This post only focuses on investment portfolio management by an Individual. There are several theories that are being propounded for the management of an Investment Portfolio. Before we move ahead let us try to understand what a portfolio is and how a portfolio investment approach differs from individual security analysis.

What is a portfolio?

A portfolio is a collection of two or more assets. When you buy a stock of company X and one stock of company Y or may be a bond of company A, you have a portfolio to take care of. The several types or classes of assets could be bought and that too in differing proportions to be included in your portfolio.

How portfolio investment is different from individual security analysis?

For the purpose of portfolio analysis and management we cannot look into each security in isolation as we do for security analysis. In security analysis we try to study an individual stock or bond and look whether it is fit to invest into or what will be its growth trajectory in the time to come (may be in long-run or short run). Whereas in Portfolio Management we look into the effect of collection of securities into a portfolio, how well they behave when clubbed with each other and how the value of complete portfolio works out to be for e.g. if a portfolio has 3 stocks each from a different company and the total value of the portfolio is $30 (value of 3 stocks), now the fourth stock is added into the portfolio by paying $10 the minimum expected value of portfolio is $40 and it should grow with time, next year we expect the value (market value + returns attained) of the portfolio to be $50 but other things being constant, now the actual value (market value + returns attained) is $ 38 that means the portfolio has lost value of $ 2 after inclusion of the fourth stock and the fourth stock is not working well with the previous three stocks.

To be honest you need to understand your own needs and investing ability and the risk bearing capacity to manage your investments. No given theory or suggested methods could best suit an investor’s individual needs, only the individual can understand and make an educated effort  to actively manage the portfolio all the suggestions and theories could well act as a guideline and could be adopted in varying proportion to suit the individual or retail investor’s specific needs.

The retail investor though is advised to follow the principles of investing in equities as these principles are really helpful in protecting and maintaining the value of the holding but the limit of usability and the flexibility in the way of execution of each of these principle has to be devised by the retail investor. Before we start discussion about key points to remember in portfolio management, let us review key principles of portfolio theory –

1.       Principle of Diversification – Securities bought should be from different sectors and different industries and should be bought at different price ranges and at different intervals. Variations in types of securities i.e. debt, long-term debt, equity and might be inclusion of precious metal and property to diversify completely will not be wrong and is advised. In India though use of property as an investment asset is not considered as part of investment portfolio. The securities bought should have varying degree of correlation so if the prices of one security take the beating the prices of the other might go up to compensate for your loos.

 

2.       Mix of Debt & Equity – The investment portfolio should hold some debt (long-term or short-term) and equities. The proportion of the two (debt vs. equity) depends upon the individual’s needs.

 

3.       Value Investing (Long –term investing) – It is proposed and their exist sufficient evidence to suggest that long-term investing results into capital appreciation and capital gain, which is actually seek by most of the individual investors. Long-term holding may result into rise in market prices of the stock but it is not a guarantee that if you hold stocks long enough, may be 5-10 years the prices will rise sometimes there are economic situations or may be other scenarios where the stock at given point of time may be selling at a price lower than the purchase price. It is advisable that investments should be made for long-term and day-trading or short-term trading should be avoided as sufficient data will not be available to take short-term buying and selling decisions. The exercise becomes very risk and almost non-scientific in short-term.

 

4.       Risk and Return – The concept of Risk and return could not be avoided and had to be ardently followed. The ability to take risk and search for the higher returns has always deluded investors but any retail investor is advised to take a well-educated decision. Key point to remember is that there is no return without taking any risk and to generate returns the risk could not be avoided. The concept of proportional risk and return also is the matter of debate as the search for significant evidence to suggest that there exists certain securities for which equitable risk and return exists.

 

5.       No use of leverage – Money to be invested in a portfolio, especially in a stock portfolio should not be borrowed or funds invested should not have interest charges attached to it, in the hope that prospective returns from the investments are going to be higher than the attached cost of funds or interest charges.

 

6.       Do not try to time the market – Most of the new naïve investors make this mistake as they try to enter into the stock market when the market has a bull run or in other words the stock prices are soaring and indices are skyrocketing. These investors enter in the hope and in search of short-term profits or expectations are to make a windfall. They buy stocks when the prices are moving up or soaring with the expectation that prices will further go up and the investors on their recent purchases will be able to make an abnormal profit that will facilitate major incomes after offsetting any brokerage charges and tax liability.

 

Usually these naïve investors are not lucky and they fail to predict the stock market movement and they keep holding their investments in the hope of further rise in prices whereas the momentum is lost and the prices started to fall.

 

Steps in Portfolio Management

 

 



 

The above process of portfolio management has to be carried out actively by the investor and an investor has to be proactive in investing and associated decision making. Point to remember is that you are responsible for your own money and value of the assets, key objective being positive movement in the value of assets!

The 3 step process seems easy but it is actually very difficult to follow and implement.

Tips for Effective Portfolio Management

1.       Invest for long-run and try to generate maximum value both in terms of capital gains (positive changes in market price of the security) and dividend income as well as interest from debt securities received over the period of time.

2.       Try to diversify to the maximum, use your knowledge and do active research for diversification. Focus should be to avoid buying too many securities of the same type and from the same company or from different companies from the same industry.  Diversification tries to minimize risk and proper diversification helps in avoiding unsystematic or company or specific security related risk.

3.       Try to match risk return profile on your portfolio. Remember no returns without risk and you cannot maximize returns at a given level of risk. Risk profiling and matching the returns for a given level of risk is important and the investor has to select optimum level of risk and based upon level of risk, he should accept the returns.

4.       A natural tendency is to look at returns only or to study returns over a period of time and then decide whether to invest or not to invest but this is an inefficient practice and should be avoided. The more educated practice is to look at your capacity to invest and ability to depart with the invested amount, if your ability to lose money is less than try to invest in less risky assets such as bonds, fixed deposits, mutual funds or debentures and be ready to accept lower rate of returns. In other words look at risk first and then try to see most optimal level of returns available for the given level of risk.

5.       Portfolio churning or pruning of securities has to be carried out at regular interval. Churning ratio should not be very high, efforts should be made to select securities with strong fundamentals and good grounding within the industry and the economy so you do not have to change or buy & sell them often. Remember more transactions means high brokerage and may be associated tax to be paid as hardly in the globe, any frequent stock transactions are independent of brokerage and associated tax liability.

How to maximize your returns from the portfolio

Consider that all the principles and tips for safe investment are being followed and now is the time of selecting the assets and looking at how the securities are to be picked so most appropriate balance within the portfolio is achieved. The starting point is your investment objectives and ability to take risk and ability to depart with liquidity or the lock-in (time when you cannot take out the money out of the security) period suitable to your level of income or expected future level of income.

The discussion to follow focuses on maximizing the returns and how you can distribute your investments in different level of securities (based upon capitalization and associated risk) to maximize the associated returns from your portfolio. This strategy is just indicative and has to be customized as per an individual’s risk appetite and objectives.

The major assumptions for this indicative strategy are –

1.       Insurance policy for life and health are different and has been treated differently. Both term plans and endowment plans are to be considered separately and not to be considered as part of this investment strategy.

2.       Real Estate investments are different and could not be directly considered as part of the suggested investment strategy.

3.       Pension products or recurring deposits are not considered as they are the essentials and they are must to have in convenient proportions before setting off the proposed investment strategy.

The indicative strategy uses an investment value (initial outlay) of $100,000. To start we will try to create some safety net by investing 30% or $ 30,000 in debt securities or mutual funds dealing with debt or income funds. Next level of investment will be to put 20% money in equity linked mutual funds or growth funds, point to consider is that high risk funds investing in buyouts or Greenfield ventures should be avoided.

Out of remaining 50% or $50,000 we will invest $30,000 in highly capitalized well consolidated stocks of recognized corporation and would hold these stocks for long-term so as to generate value or capital appreciation.

30%+30%+20% = 80% is invested or $80,000 is invested and we are left with $20,000 to play with this is also the amount with which we would like to maximize our returns but catch is also risk will be increased. This 20% could be made less and even the above proportions are suggestive not watertight or specific and an investor can adjust these investment categories as per their comfort levels and needs.

The remaining 20% should be invested into small caps or upcoming companies that showcases potential for growth both in business and customer demand for its stock and product offerings in consumer market and has high difference in their Maximum Market Value and Minimum Market Value in last 52 weeks. These shares are to be bought and observed over the period of time and should be churned (bought and sold) every month and if price prospects on fortnightly observation seems favourable could be kept in the portfolio for a month to a quarter but long-term holding should be avoided as these stocks are potentially risky and the risk increases with the time period of holding.

Portfolio Pruning and churning (time frames)

The Portfolio pruning and churning are two differentiated activities to be carried out at different time intervals and to be evaluated as per the specific need of the specific portfolio. Churning is a major activity and could be forced by several factors such as economic conditions or may be change in the legal requirements or might be made compulsory due to changes in statutory requirements. Churning means to change a portfolio or to make evaluation about portfolio performance and see how the expected returns could be maximized. An individual could plan certain strategies to alter an entire portfolio as well could go ahead and change the weights of the securities (stocks, bonds and certificates etc.) or the types of investment vehicles (mutual funds – types, fixed deposits or corporate bonds. Even period of investment could also be altered and capital market or money market securities could be included or excluded as per the specific needs of an individual) or types of investments (debts vs. equity). In simple words the properties of the original portfolio could be changed and the newly emerged portfolio might not have any resemblance to the original one.

The pruning means not to make major alteration in the portfolio but to take out non-performing assets or underperforming assets or securities and replace them with potentially more profitable assets. The basic properties or the features of the portfolio are to be kept same only certain securities are to be replaced.  The process is quite similar to weeding and an individual has to make sure that after pruning the portfolio grows and all securities perform to the best level.

The Portfolio pruning process is an ever going process and has to be carried out at least once very fortnight or on continuous basis as the need arises. This is important to make sure your portfolio stays in shape and expected returns are not compromised. While pruning make sure the strict vigilance is kept over the penny stocks or small caps and they are replaced or kept under straight proportion (lower value) in relation to the total value or the worth of the portfolio.

The Portfolio churning could be done once a year and almost all securities has to undergo the process where a retail investor has to match the performance of the complete portfolio with the performance of the market as well as each of the security with other alternatives available in the specific industry (i.e. Steel, IT, Banking and Telecom) or the asset category (Mutual Funds, Money Market Securities or Stocks).

Some theorists propounds that FDs (auto renewal) or Large Caps should not be touched in short run and kept for longer periods as their value will rise and you will get magical returns… It is not recommended to keep any Asset or Asset Category to be kept unchecked. Though the advice is not to sell any asset if the prices are found extraordinarily high or low and replace them with something which might not be an exact match or the replacement for the asset you have sold. Recommended is to check and if financial sensibilities and indicators show that the financial asset is secured and still profitable then to keep it and if possible try to diversify the portfolio by buying or bringing in more assets or assets categories.

It has to be noted that more observant you are, more aware and vigilant you are, more secured will be your portfolio and higher will be the expected returns.

 

 

 



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Decoding Human Resource Management

Introduction

The term Human Resource Management contains three separate associations that are first Human or Man or Individual second is Resources or Assets or Capital the last one is Management or Supervision or Administration. If we put the given three terms together it means Man Asset Administration or to make it simpler Supervising Human Capital.

Human resource management is related to managing the most important factor that is “MAN”, which is not only an important task but a very challenging one too. It is important because all other organizational factors are managed by this factor (MAN), and it is challenging because human nature is very unpredictable, no two people are alike in their nature – and this makes the world of human beings a rewarding experience.

The importance of the study of human resource management can be stated by the fact that an organization itself consists of many human groups which work together as a team for the accomplishment of some specific goals for which the organization has come into existence. Thus, we can say that human resource management is concerned with any activity relating to human elements or relations in organization and it is this main factor that makes an organization a success.

Meaning and Definition:

Simply put, human resource management is a management function that helps managers’ recruit, select, train and develops members for an organization. Apparently, HRM is concerned with the people’s dimension in organizations.

Definitions:

As stated by C.B. Mamoria: “Human resource management is that phase of management which deals with the effective control and use of manpower as distinguished from other sources of power.”

According to Edward Flippo: “ personnel management is the planning, organizing, directing and controlling of the procurement, development, compensation, integration, maintenance and separation of human resources to the end that individual, organizational and societal objectives are accomplished.”

To understand the term HRM meticulously we need to see it as a system in which participants seeks to attain both individual and group goals. Following on the footsteps of management HRM also proclaims the attainment of super-ordinate goals while helping the involved individuals to attain their respective objectives.

Figure 1: HRM as a System for Goal Attainment

Scope of HRM:

The scope of HRM is very vast. Particularly, the activities included are – 

•    HR Planning
• Job analysis and design
• Recruitment and selection
• Orientation and placement
• Training and development
• Performance appraisal and job evaluation
• Employee and executive remuneration
• Motivation of the workforce
• Communication within the organization
• Welfare, safety, and health, industrial relations etc.

Figure 2: Scope of HRM

Importance of HRM:

·         Proper management of human resources enhancing their dignity by satisfying their social needs.

·         Maintaining a balance between the jobs available and the job seekers.

·         Providing suitable efficient effective and most productive employment to human resources.

·         Making maximum utilization of the resources in an effective manner and paying the employees a reasonable compensation.

·         Doing away with improper use of human resources and providing them with workable environment and protecting their health.

·         Helping human resources make healthy decisions and protecting their interests.

·         Promoting team work and team spirit among the employees.

·         Providing opportunities for personal and professional development.

·         Maintain healthy relationship between different work groups so that work is effectively performed.

·         Improving the employees working skills and capacity.

·         Reallocation of work so as to enhance working capacities of workforce.

·      Creating right attitude in human resources by motivating them.

·         Effective utilization of available human resources so as to facilitate organization attain its objectives.

·         Securing willing cooperation of the employees and fulfilling their own social and other needs.

 

The HR manager:

The HR manager is a generalist rather a non-specialist who oversees or governs as well as coordinates programmes cutting across all functional areas. The HR manager is typically a top-ranking individual in an organization who oversee how human beings involved in each of the operational department are functioning as well as what are the requirements of each of the operational unit moreover how each functional unit could be made more effective and efficient by providing most apt and job-fit human resources.

 

 

 

 

Figure 3: The Tasks of a HR Manager

The following qualities can make a successful HR manager:

The HR manager ought to be fair and firm, sensitive and thoughtful, tactful and resourceful, practical and imaginative, sympathetic and considerate, knowledgeable about labour laws, have a wide spectrum of information along with broad social outlook, and have competenceand confidence, should also be trust worthy, should have excellent image in the corporate as well as among employees, good communication skills, should have good convincing skills, and an adorable balancing nature and personality.

Conclusion

Till date taken not so seriously the human resource department has become very important in this modern era as now it has become a well known fact that in order to survive in this fierce competitive world onlythe Human factor cannot be copied by your competition so human assets or human resources has to be managed well so as to have competitive advantage or an edge over your competitors. We need to understand that the true value generator for any organization is human resources andit should also be noted that in order to succeed the Human Resources are to be managed strategically. We need to remember that the ‘The true essence of any organization is its members.’

Equity Investing Pointers for a Lay Man

Equity Investing Pointers for a Lay Man

Investing is a must exercise for everybody looking at the growing rate of inflation and ever-expanding demands of family and society standards. Everybody is making an effort to uplift standards of living, which in a way is a good sign but it is a daunting task for those bread earners who put in hard-work and long-working hours to make sure that their family has a comfortable and secured life.

Investments are essential for securing your retired life as well as to meet contingency requirements. As it is known in common parlance there are several vehicles of investment and there are several instruments available to invest i.e. Bonds, Equity Shares, Debentures, Saving Certificates and Fixed Deposits.

Most of the Investments could be categorized into either Debt (loan resulting into interest receipt and principal payment) or Equity (risk based, ownership based resulting into capital or value appreciation). An individual investor could make or select any type of investment depending upon his or her risk preference (high risk VS. low risk) or ability to invest (amount of money)and preference for being invested (time horizon). To understand the basic premise let us take an example –

Ms. A could invest $ 10,000 for 5 years in a 5 year bond, as she wanted to take less-risk and could easily do away with $10,000 for 5 years as there is no evident need for her to use that money. Whereas Ms. B has invested $100,000 in equity shares, she wants more returns by taking higher risk and she has not time frame in mind as she has sufficient income and liquidity (availability of cash) to meet all her present and future requirements.

The above example helps to put some light on basic investment philosophy. This article focuses primarily in Equity investments or stocks as some call them. We need to clarify one thing about investments in equity, that they cannot be termed or considered as your savings though they might have been taken from your savings or may be from your current income or cash flow but the equity investments are neither savings nor similar to savings. Up to extent money parked into your debt instruments or fixed deposits could be considered as savings as it is almost cash like or cash equivalent, could be easily converted into cash as and when needed. The quick conversion to cash or being a cash equivalent both features are non-existent in equity investments.

Undeniably some products are available in the market that prompts you to invest your savings into equity but the product in itself is risky and associated with changes in value (value might go up or down) of the investment (product or asset). We do not expect value of our savings to go down!

Starting with General Guidelines for a beginner, following are the few tips to be kept in mind so you can make some educated decision whether the equity investments are for you or not.

1.       Do you have capacity to lose money! Sorry but there are chances that you might end up losing some money on your investment as the equity prices could not be controlled as the rate of interest on your savings account.

2.       Your capacity to take risk or appetite for risk – If you can invest some money and just wait and actively monitor the situation without withdrawing the funds then only consider parking your money into equity. Plus make sure the negative changes in the value of your investment do not have significant impact on your behavior or financial position.

3.       Could you manage your investment actively and ready to do some research – if you have time and you can be proactive in managing your money than only equity investments are for you otherwise debt makes more sense. Undeniably you can use mutual funds but still you need to manage your money or have information to select most appropriate mutual fund or switch between the schemes or securities.

4.       Long Term – The term or the time-frame is the key to generate value in equity investments so you should have the capacity to lock in you money for at least 5 years, remember that may generate some tax advantage for you as well. Remember to set long-term goals and how your investments in equity should work so the goals could be realized effectively.

5.       Make yourself aware of Dos and Don’ts of the stock market. Reading is the Key! Avoid picking scrips or companies to invest based upon emotions or hunches. Another Important Don’t is not to take a loan to invest in stock market (equity investment). Make a point to diversify your portfolio by buying good quality stocks of different companies ranging over different sectors or industries. Stocks should be bought from banking sector, IT sector, Telecom, Infrastructure and FMCG.

Pointers to Make an Investment in Equity:

If you have read so much and have reached to this stage than it means you are serious ready to invest in equity. There are several jargons and terminology i.e. Fundamental Analysis, Technical Analysis, Economic Analysis and Dow Theory etc., that are being used and some of them seems to be bit complicated rather high-end for a lay man to use.

Here an Effort has been made to provide you simplistic pointers that can facilitate you in making right selection for your equity investment portfolio. Most of this information could be collected via websites or stock exchange apps or may be via magazines or journals. This information is primarily available in public domain.

Following is the information or pointers that you should try to study or find out information about them so you can make a well judged investment.

1.       History of the Company – Past is always a Guiding Force as it tells a lot about how the company has progressed over a period of time.

2.       Basic Understanding of the Company’s Business – Invest if you understand the company’s business and the product of the company seems to be in the demand for a long-period.

3.       Reputation and Experience of the promoters and Board of directors

4.       Customers and Type of Markets being served by the company – Loyal Customers and International Customers is an asset.

5.       High & Low price of a Year or at least for last 6 months – Newer Buy at the peak price try to buy as close as possible to the lowest price

6.       Revenue of the Company for last 5 years – It will give you an idea how much company makes in a year and its capacity to generate income. You could also do year –on – year comparison.

7.       Net Profit after Tax for last 5 years – This is what will be distributed to the shareholders as earnings per share (EPS)

8.       P/E Ratio – Price Earning Ration in simple words it means current market price per share divided by Earning per Share. E.g. Stock is trading at INR 100 and Earning per share last year has been INR 5 then P/E ratio is 100/5= INR 20/-

9.       Competitions for the Company – More Competition more are the challenges that the company has to face in the market.

10.   Focus on the Future of the Company – Vision that the company holds for the future and concrete planning for growth.

 

 

Useful Links - Other Publications

Useful Links -

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1625400

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1666746

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1693783

http://www.ripublication.com/Volume/gjfmv3n1.htm

http://ijrcm.org.in/download.php?name=ijrcm-3...1.../ijrcm

www.indianmba.com/Faculty_Column/FC707/fc707.html

www.indianmba.com/Faculty_Column/FC1191/fc1191.html

 

Modern Day Financial System and Economic Development - Analysing the Relationship

Financial Functions and Economic Development

Functions of Facilitating Risk Management

It is generally believed that an important role of a financial system is to reduce the risk in trading and in pooling. There are two distinct types of risks: liquid and illiquid risks. For example, the liquidity of real estate is less than equities and therefore real estate has high liquidity risk. Liquidity risk arises due to the

uncertainties in the process of converting assets into a medium of exchange. Liquidity risk could rise because of asymmetries of transaction and information costs, and financial markets and institutions will arise accordingly. Thus, we can define liquid markets as the markets which involve less uncertainty in settling the trading. During the recent decades, the establishment of financial systems in response to liquidity risk has been always debated by economists, and the association of financial

systems and economic development has been evaluated in various ways.

The first way is introduced by Diamond and Philip that is named as the Seminal Model of Liquidity

.

According to that model, savers in markets have the possibility of receiving shocks after choosing between liquid project (High return) and illiquid project (low return), and that risk can encourage more investment in the liquid (low return) projects. Supposed that it is expensive to receive a shock in this model, so that the insurance contracts need to be ruled out and financial markets will exist, where individuals can trade securities with higher confident level. Stock markets reduce liquidity risk by facilitating the trade and thus more projects will be invested with the high return. On the basis of above discussion, information costs, with which agents can verify whether other investors receive shocks, are the main cause for the emergence of the stock market. Moreover, it is noticed that trading costs are also able to highlight the significance of liquidity. But if this economic activity is expensive, production technologies will be less attractive due to its longer period. Therefore, liquidity affects the production decisions, which can be measured in trading costs in secondary financial market and thus greater liquidity will result in transferring to longer period

and higher return technologies.

After the parts about liquidity risk, it in turn seeks to explore the association between financial intermediaries and the economic development. The definition of financial intermediaries is generally concluded as the combination of agents to provide financial services, and thus financial intermediaries can be used to strengthen liquidity, and also to reduce risk from liquidity. On the basis of the discussion in the previous part, the Diamond-Dybvig Model assumes that it is not possible to make insurance contracts in the market, and thus savers can get liquid deposits from banks. Furthermore, the liquid risk can be reduced by a completed insurance provided by the bank, while the long-term investments could be facilitated in high return projects. By reducing liquidity risk, investment can be increased in the high-return projects, which normally is described as the liquidity asset; and then the economic growth will be promoted. But all of those studies about the functions of banks are based on the assumption of lack of state-contingent insurance contracts (Diamond-Dybvig Model). But this assumption simultaneously brings a problem about describing how a bank reduces liquidity risk. In other words, if there is a market of equity, agents in the market prefer to using equities and then nobody has inventive to use financial institutions. After considering the main role of reducing the risk of liquidity, other risks associated with individual industries could also be reduced by an efficient  financial system.

Indeed, one primary role of financial markets is to provide services for diversifying and trading various risks. The ability of financial system to offer the service of risk diversifications can influence the process of economic development by changing allocation of resources and by arranging the saving rates. Therefore, financial markets tend to make portfolio investment shift to the higher-returns projects (Paul; Obstfeld).

The risk diversification not only has an effect on capital accumulation, but also makes changes of the technological innovative advances. Agents in the marker are trying to make technological advances to get profits for the innovators, and thereby successful innovation can improve the process of technological advances. The ability of holding a portfolio of innovation projects is able to reduce risk, and also investments are promoted in enhanced innovative activities. In conclusion, financial systems play an important role in facilitating technological advances and promoting economic development through their effects on improving risk diversification effectively.

Functions of Financial Systems and Allocation of Resources

In order to promote economic development, it is crucially important to allocate and mobilize sufficient resources for various investments and the quality of the allocation to different investments play a critically significant role on economic development. Economists have identified various mechanisms to explain the positive influence of financial intermediation on the capital productivity. Actually the allocation of resources includes three important critical points that are associated with the establishment of financial institutions—the diversification of risks, the management of liquidity risks, and the evaluation of managers’ skills in enterprises. But since the management of risks has been discussed in the previous subsection, this subsection will only concentrate on two parts. On the basis of these three factors, different economists present various arguments about the possible influence to the economic development. For example, Greenwood and Jovanovic contends that the influence on the growth is due to an increase in the resources invested in productive capital and an 

improvement in productive efficiency. Here, there are two points needed to be known:

a) the returns on investment are associated not only with some risks in the productive

process, but also with other risks associated with future product demand;

b) all intermediation activities can be carried out either by banks or financial markets.

Therefore, the development of financial markets helps agents reduce those risks with the efficient diversification of their investments, and simultaneously choosing more productive technological advances. On the basis of this view, because of the higher level of opportunity costs involved in flexible technology, the development of financial markets becomes much more attractive for investors. The dualism way of technology is able to be described as an important method of diversification of technological risk, while productive risks can not be diversified in the modern sector effectively due to less-developed financial markets and intermediaries, including stock markets and banks.

The assessments will take place in the process of monitoring the various kinds of investments, and the costs of these assessments include fixed costs basically. Supposed those fixed costs are enough high, individual investors would be encouraged from conducting that research. Furthermore, this will result in an increase

in the investment in bad risk projects and a decrease in the productive efficiency of investment, and thereby has negative influences on economy development. The emergence of those fixed costs can be described as an important incentive to found specialized financial institutions which is used to integrate the information on

investments. If such information can be collected for an enough amount of investors, financial intermediaries will spread the fixed cost among the whole participated investors. Therefore, investment projects are more productive and this has a positively critical influence on economic development accordingly.

There is another kind of view about the monitoring effect on financial intermediaries. Agents in markets have their own choices between two types of investment projects: the investment with high productivity but low risk; the investment with low productivity but high risk; the risky investment is constrained to the technological shock. Unless individual agents are able to spend more money in monitoring others, private investors can not normally observe the shock affecting their investment projects. On the basis of this view, the financial  ntermediation can also be described as a systematic network, which works to connect various individual

investors and facilitate the diffusion of information on the return of individual investments, so that financial intermediaries are able to obtain information about the shocks to affect investments. In conclusion, there are two summarization points needed to understood in this subsection:

a) Due to more informed breakdown of shocks, financial intermediaries can make investment go towards the invested projects with more yields and profits;

b) agents can reduce the risks in private projects better due to monitoring the systematical shock and there will be an increase in resources allocation invested risky but productive investments. The results both accelerate economic growth, as well as promote the development of entire economies.

Functions of Mobilizations of Savings

Another important function of financial intermediaries and markets is concentrating how to mobilize available savings efficiently in an economy. Indeed, the emergence of financial systems and intermediaries provides an efficient way of mobilization and pooling of available savings, which can integrate existing financial resources from individuals to group investments. Actually more advanced technological innovations can be used in the process of production, which initially required a certainly higher level of investments. The mobilization includes some instruments, with which investors are able to keep diversified portfolios, then to spend more investments in efficient firms and to raise the degree of liquidity of financial assets. Therefore, mobilization has a definitely positive influence on the allocation of resources, by improving the diversification of risks and the size of firms.

This means the financial intermediaries can offer investors the relatively higher expected returns in the process of resource integrations, which in turn results in an increase in capital productivity and also individual household can obtain the more profitable yields. However, for every individual investor it must be very expensive to mobilize and pool the savings by himself due to much high cost involved in the process of the integration of resources. Among various costs, there are two most important costs to be studied here: a) costs of transaction, which come from pooling savings from every investor; b) costs of informational asymmetries, which make investors feel better to give up the control of their long-period savings. In facts, around the mid-1880s some bankers have already used some connections in Europe to increase capital overseas

for investments in the America, while other banks also attempted to find the connections with banks and entrepreneurs in the USA to start the steps of capital mobilization. At the same time, other banks also wanted to sell securities to individual households through some other methods—such as advertisement. Furthermore, financial intermediaries are generally required to have a good reputation, and then savers will feel comfortable about consigning their savings in the banks , since agents of conducting the mobilization have to tell the investors with the rationalization of investments. Although many transaction and information costs have to be suffered under the process of the saving mobilization, there are various financial policies to solve these frictions and to improve the ability of pooling. For example, numerous multiple contracts are made in the mobilization, and these contracts take place between productive units and agents with surplus resources.

The joint stock company shows us an example of multiple mobilization, with which a new legal entity—the

firm—can be invested by many individuals. Also pooling might take place here with intermediaries, and here many investors consign their money in intermediaries which invest in firms . The efficient mobilization and pooling of savings not only have effects on the accumulation in capital, but also have positive influences on improving the allocation of resources, as well as creating the innovation of technological advances. When

financial systems are more effective at pooling the savings from individuals, they can deeply influence economic development. In addition, the development of financial intermediation can lead to releasing the constraint of liquidity, which agents in the  economy have to face when planning their consumption through the life. Consequently, when liquidity constraints could be released, the savings rate will fall down. This positive relationship between the liquidity constrains and the saving rate has been empirically evaluated by Jappelli and Pagano with a case study of OECD member countries. But here we have to underline an important assumption, since any discussions of the liquidity constraint on the economic development are based on that consumption: productivity gains are only connected to externalities in the accumulation of physical capital. However, if the liquidity constraint leads to the encouragement of savings, the negative effects will exist on economic growth.

This situation occurs if growth arises from the accumulation in human capital instead of only in physical capital, since the probability of individual borrowing in the time of schooling would be reduced. Therefore, through the affects of externalities, the emergence of liquidity constraints, based on the less-developed financial system, can make the choice of a low equilibrium with weak growth, and thereby a trap of poverty

correspondingly.

Functions of Being Payments System

Another significant distribution of financial systems to economic development comes from the establishment of an efficient and adaptable payment system. That means the influence from a financial system to the economic development can be discussed with reference to a well-performing payment system in the financial markets. Empirically, a creditable means of exchange is a necessary condition to promote the economic

development. If the payment system is now assumed not to exist, the transaction costs may offset some gains in productivity, which is linked to the division and the beginning of partial economic growth. And payment systems can interactively adapt with the process of economic development. Here, the definition of economic

development does not only imply the sustained productivity gain, but it also mean a maintained opening up of new markets and an efficient diversification of products. All of these economic activities lead to the more exchanges, which will make an economy more complicated. Then, there will be a growing demand of monetization, which should be necessary for sustaining the economic growth. Finally, there will be long-term trend towards a reduction in the money velocity and this conclusion been confirmed by many experiences from most developing countries. Furthermore, it is necessary to mention the need to reduce the opportunity cost of keeping money, which brings a stable movement trend of payment systems towards credit connections supervised by financial intermediaries, and this trend might be strengthened by the process of technological advances. But these technological advances can not only reduce the information costs that are linked to credits, but also they are easily able to make modernistic financial assets substitutable for conventional financial assets. That is initially shown by a long-term increase in the ratio of financial activities to entire GDP, and also working population in financial sectors is increasing sharply correspondingly, and thereby that will have a critically positive influence on the economic development. However, this fall seems to be confirmed by the wide money aggregates and the notion of wide money aggregates includes more complex kinds of financial assets, whose high cost implies that they only become accessible beyond a certain level of economic development.

Actually, the positive relationship between real GDP and the ratio of the financial assets to GDP (traditional

expression of monetization) was discussed and highlighted in initial studies on financial growth and economic development.

 

Conclusion

The above discussions have illustrated a functioning approach of the main functions of a financial system associated with economic development. But it seems to be too narrow a focus to evaluate the influence on economic development from every separate function, so that many economists encourage various functions into an integrated understanding of the functions of a financial system to help economic development. Actually it is better way to study the financial system functions with the integration of the different individual functions. In fact, by identifying the individual functions performed by the financial system, the functional approach can motivate a more complete understanding of relationship between financial growth and economic development.

There were some good studies provided by earlier economists to evaluate the associations between finance and development. For example, Schumpeter (1912) explores a board explanation of the roles of a financial system on economic development. It looks like Smith (1776) uses the key factor to explain the importance

of the process of specialization. Schumpeter uses the ties between firms and banks to explore the significance of the financial system on adopting the technological advance

and innovation. McKinnon underlined the significance about facilitating the use of the efficient agricultural techniques. Consequently, all economists believe that it is necessary to integrate all individual roles into a simple way about how the financial system affects economic development as a whole. Moreover, all of individual functions of financial system on economic growth must be interactively discussed and most economic activities should include the interaction of individual roles, rather than considering only one function solely.

Vivek Joshi

Director

Creative Head Consultants