Analysis of Brokerage Firms and Moral Hazard in Finance Accounting

This accounting assignment delves into the operations of brokerage firms and the concept of moral hazard within the financial sector. The assignment begins by defining brokerage firms as intermediaries facilitating securities trading, highlighting the role of investment banking companies like JP Morgan and Goldman Sachs. It explores how these firms leverage information reusability, discussing both its benefits in reducing redundancy and its potential downsides regarding data security. The assignment further examines quality asset transformation (QAT), a process by which companies create new assets from liabilities, and discusses how financial institutions manage related risks through acceptance, diversification, or risk-shifting strategies. The second part of the assignment focuses on moral hazard, a situation where one party takes on more risk knowing another party will bear the cost, particularly in the context of financial institutions. It emphasizes the role of financial intermediaries in mitigating moral hazards by monitoring borrowers and analyzing market information. The assignment concludes by underscoring the importance of financial intermediaries in managing the vast amount of information in financial markets to prevent fraud and protect stakeholders.

Accounting
Assignment

By student name
Professor
University
Date: 4th December,2018.
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Table of Contents
Question 1.................................................................................................................. 3
Question 2.................................................................................................................. 3
References................................................................................................................. 5
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Question 1
Brokerage firms are simple institutions that helps in trading of securities between the buyer and
the seller. In today’s world there are many banks that works as brokers to facilitate these services
and they are known as investment banking company.Brokerage refers to joining unfamiliar
transactions in financial claims. They maintain a primary brokerage account to assist their
operations. There are several investment banking companies around the world like JP Morgan,
Goldman Sachs etc. They provide such services to people that they trust the companies with their
information (Abdullah & Said, 2017). For all the services the commission that the company
earns is known as brokerage. In case of banks informational asymmetries includes detail
information about the credit market, but some banks also try to gather information about the
clients to gain advantage over their competition in the market. The banks try to maintain the pre
and post asymmetric information spread so that they can earn the difference between the spread
and make some money from the same. The pre contract information consist of adverse selection
and duplicated screening and post contract information consists of moral hazards. This
information is an important determinants of industry structure in the company. Given the
characteristics involved with corporate banking companies, they get an added advantage with the
customer information that they have with regards to other banks (Boghossian, 2017).
Information reusability impacts the activities of the banks, as they have huge power to reuse the
information that they have collected in and around the market about credit worthiness of
customers and official channels of flow of funds more then what individual brokers can handle.
There are two types of information reusability known as cross sectional and Intertemporal. So,
they can use these information in various ways and help the customers in getting added benefits,
but it has a downside also as we see that many banks are often not able to keep this data
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confidential and that leads to loss of information on many grounds and data is used in a wrong
way. So, we see that to maintain the security of the same and use it in a feasible manner banks
should try to manage the data and procure and present it to relevant channels of distribution. But
in information reusability is a great way of reducing the redundancy of information and make it
better useable. In past a lot of frauds have occurred because companies were not able to keep the
data safe and destroying the authenticity of the same have a lot of effect on the customer. Banks
can keep the data safe thus people believe on banks rather than individuals and single brokers
who deal with securities.
Quality Asset Transformation is a process by which companies can create new assets from
liabilities that are having different characteristics and converting the small denominations of the
same, immediately available and assets that are relatively risk free in the market, this will lead to
low risks and large denomination assets and better flow of the funds. Typically banks and other
financial institutions perform asset transformation by offering customers with a variety of
financial products that are there on the both side of the balance sheet and investment and loan
products are included in the same. Risk is an important part of QAT. Three alternatives available
to F.I.s to Manage this risk:
Accept risk passively
Diversify and reduce risk
Shift risk to others through the use of claims such as swaps, forward contracts, futures, options,
swaptions, etc.
So, we see that managing the same has helped the companies in reusing the information
effectively and taking hold of the same. Information reusability is something that banks can use
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effectively in case of asset transformation. And thus, that solves the problem of data redundancy
and making it more effective. Quality Asset Transformation is one of the effective and efficient
way of managing the assets of the company. It helps in securing the information and making it
available for large scale use.
Question 2
Moral Hazard, is a situation in which one party is getting involved in a transaction knowing that
the other party is taking risk and in case there is any mishap, the other party will incur the cost of
the same. This will occur when the information is not complete about each other. Moral hazards
can lead to losses that would lead to dishonesty (Cayon, et al., 2017). There are many companies
that suffer losses due to fraudulent or inflated claims. In banking companies and financial
institutions, they are bearing the risk of writing of shares, and since they are bearing the cost of
the same, there are high chances of moral hazards that they may suffer due to false claims and
information that they have received (Johan, 2018).
Financial intermediaries play an important role in reducing the moral hazards through their
services, by regulating and keeping a watch on how the borrowers are using the borrowed funds
that they are getting. They can also do a thorough research of the market and the information that
they are getting from the customers and they can analyze the correctness of the same. So we see
that with their effective services they can regulate the various frauds that are occurring all around
the world, due to lack of secure channels that lead to losses on part of various individuals who
are misusing the system of debt and maintenance by mis appropriately mishandling the funds
that they have received and leading to more loss as other people are bearing the loss on part of
them (Johan, 2018). There are vast issues that are involved with large amount of information that
are there in the financial markets and managing the same is a task, and financial intermediaries
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helps in categorizing this information and regulating the same so that companies on many ends
do not suffer (Sinclair, et al., 2007).
References
Abdullah, W. & Said, R., 2017. Religious, Educational Background and Corporate
Crime Tolerance by Accounting Professionals. State-of-the-Art Theories and
Empirical Evidence, pp. 129-149.
Boghossian, P., 2017. The Socratic method, defeasibility, and doxastic
responsibility. Educational Philosophy and Theory, 50(3), pp. 244-253.
Cayon, E., Thorp, S. & Wu, E., 2017. Immunity and infection: Emerging and
developed market sovereign spreads over the Global Financial Crisis. Emerging
Markets Review.
Johan, S., 2018. The Relationship Between Economic Value Added, Market Value
Added And Return On Cost Of Capital In Measuring Corporate Performance. Jurnal
Manajemen Bisnis dan Kewirausahaan, 3(1).
Sinclair, R., Leo, M. & Wright, C., 2007. Benefit System Effects on Employee Benefits
Knowledge, Use, and Organizational Commitment. Journal of Business and
Pyschology, 20(1), pp. 3-32.
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