are overwhelmingly financial. Table 1.7 shows that the balance sheets of financial institutions include very small amounts of tangible assets. Compare Table 1.7 with Table 1.5, the balance sheet of the nonfinancial corporate sector. The contrast arises precisely because intermediaries are middlemen, simply moving funds from one sector to another. In fact, from a birds-eye view, this is the primary social function of such interme- diaries, to channel household savings to the business sector. Other examples of financial intermediaries are investment companies, insurance com- panies, and credit unions. All these firms offer similar advantages, in addition to playing a middleman role. First, by pooling the resources of many small investors, they are able to lend considerable sums to large borrowers. Second, by lending to many borrowers, inter- mediaries achieve significant diversification, meaning they can accept loans that individu- ally might be risky. Third, intermediaries build expertise through the volume of business they do. One individual trying to borrow or lend directly would have much less specialized knowledge of how to structure and execute the transaction with another party. Investment companies, which pool together and manage the money of many investors, also arise out of the "smallness problem." Here, the problem is that most household port- folios are not large enough to be spread across a wide variety of securities. It is very ex- pensive in terms of brokerage and trading costs to purchase one or two shares of many I. Introduction 1. The Investment Environment The McGraw−Hill Companies, 2001           12 PART I Introduction     different firms, and it clearly is more economical for stocks and bonds to be purchased and sold in large blocks. This observation reveals a profit opportunity that has been filled by mutual funds offered by many investment companies. Mutual funds pool the limited funds of small investors into large amounts, thereby gain- ing the advantages of large-scale trading; investors are assigned a prorated share of the to- tal funds according to the size of their investment. This system gives small investors advantages that they are willing to pay for in the form of a management fee to the mutual fund operator. Mutual funds are logical extensions of an investment club or cooperative, in which individuals themselves team up and pool funds. The fund sets up shop as a firm that accepts the assets of many investors, acting as an investment agent on their behalf. Again, the advantages of specialization are sufficiently large that the fund can provide a valuable service and still charge enough for it to clear a handsome profit. Investment companies also can design portfolios specifically for large investors with particular goals. In contrast, mutual funds are sold in the retail market, and