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Banking

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Published in: Economy & Finance, Business

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  • 1. Chapter 3: Financial Instruments, Markets and Institutions
    • Financial Instruments
    • Financial Markets
    • Financial Institutions
  • 2.
    • People who need funds
      • borrowers/issuer/seller
    • People who have funds to give
      • lenders/savers/buyers
  • 3. Indirect vs. Direct Finance
    • Indirect finance
      • Borrowers and lenders meet through a financial intermediary (e.g. bank)
      • Loan is a liability for borrower, and asset for a bank
  • 4.
    • Direct finance
      • Borrowers sell securities directly to lenders
      • e.g. corporate and Treasury bonds
  • 5.  
  • 6. I. Financial Instruments
    • aka. securities, financial assets
    • definition (p. 36 (1 st ) or 41 (2 nd ))
    • = written legal obligation of one party to transfer something of value, usually money, to another party at some future date, under certain conditions
    • a security is an asset for the buyer/lender,
    • but a liability for the issuer/borrower/seller
  • 7. example
    • shares of stock in Time Warner, Inc.
      • shares of ownership in TW
      • a claim on the earnings/assets of TW
      • a liability for Time Warner
      • an asset for me
  • 8.
    • my mortgage
      • I am the borrower (liability)
      • the bank is the buyer/holder (asset)
      • the bank has a claim on my house
  • 9. uses of financial instruments
    • means of payment
      • but much less liquid than money
    • store of value
      • better than money over time, but also greater risk
    • transfer of risk
      • buyer transfers risk to seller
      • e.g. insurance policies, futures contract
  • 10. Valuing financial instruments
    • sizing, timing & certainty of promised cash flows
    • Size: how much is promised?
      • the larger the cash flows, the greater the value
    • Timing: when is it promised?
      • the sooner the cash flows are received, the greater the value
  • 11.
    • Certainty: how likely its it that payments will be made?
      • the likelier the payments the greater the value
    • Under what conditions?
      • e.g. insurance, derivatives
      • payments when we need them the most are more valuable
  • 12. examples
    • bank loans
    • stocks
    • bonds
    • home mortgages
    • asset-backed securities
    • option and futures contracts
    • insurance policies
  • 13. II. Financial Markets
    • where financial instruments are bought and sold
    • these markets provide
      • liquidity for buying/selling
      • information through prices
      • risk-sharing among buyers/sellers
    • classified in various ways…
  • 14. Primary vs. Secondary Markets
    • primary market
      • newly issued securities
      • -- investment banking
    • secondary market
      • brokers match buyers and sellers
      • dealers act as buyers and sellers
      • -- “market-makers”
  • 15. Debt vs. Equity Markets
    • debt security
      • cash flows are fixed
      • bonds, loans
    • equity security
      • cash flow variable, residual
      • common stock
  • 16. Exchanges vs. OTC Markets
    • exchange
      • buying & selling of securities in physical location
      • NYSE
    • OTC (over-the-counter)
      • dealers in many locations buy & sell securities
  • 17. Money vs. Capital Markets
    • money market
      • short-term debt securities (up to 1 yr.)
      • highly liquid, low risk
    • capital market
      • longer-term debt
      • equity
  • 18.  
  • 19.  
  • 20. III. Financial Institutions
    • aka. financial intermediaries
    • Why have them?
    • Transactions costs
      • search costs to find borrower & lender
      • contract costs
      • economies of scale
  • 21.
    • Risk sharing
      • intermediaries are experts at bearing risk
    • Asset transformation
      • short-term to long-term
      • illiquid to liquid
  • 22. Types of intermediaries
    • Depository institutions
      • “banks”
      • accept deposits, make loans
  • 23.
    • Commercial banks
      • largest in total assets
      • least restricted
    • Savings & Loans
      • originally restricted to savings deposits and mortgages
      • less restricted today
    • Credit Unions
      • consumer loans
      • nonprofit, organized around a group
  • 24.
    • Nondepository institutions
      • insurance companies
      • pension funds
      • finance companies
        • Mortgage, auto, office equipment
      • Securities firms
      • gov’t-sponsored enterprises (GSEs)
  • 25. Subprime mortgage meltdown
    • Hit several types of financial institutions:
      • finance companies
        • Countrywide
      • securities firms
        • Citigroup, Merrill Lynch
      • GSEs
        • Fannie Mae, Freddie Mac