Financial Institution and Regulation

JINNAH UNIVERSITY FOR WOMEN
DEPARTMENT OF COMMERCE
ASSIGNMENT
Point Counterpoint and Flow of Fund Exercises
NAME
Wajiha Muhammad Ismail
DEGREE PROGRAM
BS-Commerce (IV)
SUBJECT
Financial Institutions and Regulations
(FIN-4035)
SUBMISSION DATE
June 02, 2022
SUBMITTED TO
Ms Mehwish Zia

Department of Commerce Jinnah University for Women
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Contents
Chapter # 01 Role of Financial Market and Institutions........................................................3
Point Counter-Point................................................................................................................3
Flow of Funds Exercise..........................................................................................................3
Chapter # 06 Money Market..................................................................................................5
Chapter # 10 Stock offerings and investor monitoring..........................................................6
Chapter # 13 Financial Future Market...................................................................................8
Chapter # 17 Commercial Bank Operations..........................................................................9
Chapter # 18 Bank Regulation.............................................................................................10
Point Counter-Point..............................................................................................................10
Flow of Funds Exercise........................................................................................................10
Chapter # 19 Bank Management..........................................................................................11
Chapter # 20 Bank Performance..........................................................................................13

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Chapter # 01 Role of Financial Market and Institutions
Point Counterpoint
Will Computer Technology Cause Financial Intermediaries to Become Extinct?
Who Is Correct?
Ans. My opinion counter point is right because financial intermediaries serve as the middlemen
between investors and borrowers while creating an efficient market for both parties. In an
article, financial intermediaries exist because they improve on markets without an
intermediary. They are equipped with the knowledge and expertise to effectively cater the
needs of the parties involved. Financial intermediaries also provide benefits for its clients They
include:
(1) value transformation where financial intermediaries can pool together many smaller
deposits and lend a smaller number of enormous amounts of money to borrowers,
(2) maturity transformation where they provide long-term funds to borrowers, whilst ensuring
that depositors retain the level of liquidity they require,
(3) reduction of transaction costs where they can reduce the transaction costs associated with,
for example, writing contracts for borrowers and lenders, and
(4) risk diversification for savers where if a borrower defaults on a loan, the savers should not
be directly affected as the cost will be charged to the financial intermediary, not the depositors;
the return on an individual's savings are not reliant on the performance of one borrower.
With these benefits mentioned, it is evident those financial intermediaries exist for a reason
and that no advancement of computer technology will cause their demise as an industry because
individuals need the assistance of these financial intermediaries when making their decisions
Flow of Funds Exercise
Roles of Financial Markets and Institutions
Q1. In what way is Carson a surplus unit?
Ans. Carson invests in treasury securities and therefore is providing funds to the treasury, the
issuer of those securities.
Q2. In what way is Carson a deficit unit?

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Ans. Carson has borrowed funds from financial institutions.
Q3. How might finance companies facilitate Carson’s expansion?
Ans. Finance companies can provide loans to Carson so that Carson can expand its operations.
Q4. How might commercial banks facilitate Carson’s expansion?
Ans. Commercial banks can provide loans to Carson so that Carson can expand its operations.
Q5. Why might Carson have limited access to additional debt financing during its growth
phase?
Ans. Carson may have already borrowed up to us capacity. Financial institutions may be
unwilling to lend more funds to Carson if it has too much debt.
Q6. How might securities firms facilitate Carson’s expansion?
Ans. First, securities firms could advise Carson on its acquisitions. In addition, they could
underwrite a stock offering or a bond offering by Carson.
Q7. How might Carson use the primary market to facilitate its expansion?
Ans. It could issue new stock or bonds to obtain funds.
Q8. How might it use the secondary market?
Ans. It could sell its holdings of treasury securities in the secondary market.
Q9. If financial markets were perfect, how might this have allowed Carson to avoid
financial institutions?
Ans. It would have been able to obtain loans directly from surplus units It would have been
able to access potential targets for acquisitions without the advice of investment securities firms
It would be able to engage in a new issuance of stock or bonds without the help of a securities
firm.
Q10. The loans that Carson has obtained from commercial banks stipulate that Carson
must receive the bank’s approval before pursuing any large projects. What is the purpose
of this condition? Does this condition benefit the owners of the company?
Ans. The purpose is to prevent Carson from using the funds in a manner that would be very
risky, as Carson may default on its loans if it takes excessive risk when using the funds to

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expand its business. The owners of the firm may prefer to take more risk than the lenders will
allow because the owners would benefit directly from risky ventures that generate large returns
Conversely, the lenders simply hope to receive the repayments on the loan that they provided,
and do not receive a share in the profits. They would prefer that the funds be used in a
conservative manner so that Carson will generate sufficient cash flows to repay the loan.
Chapter # 06 Money Market
Point Counterpoint
Should Firms Invest in Money Market Securities?
Who Is Correct?
Ans. Both arguments are correct. A money market investment has both pros and cons, there
cannot be any absolute decision. The argument against says firm's objective is maximization
of shareholder returns, and money markets offer lower rates on investment Firm need money
markets for liquidity. money market funds invest to highly liquid securities like cash, cash
equivalents, and high-rated debt-based securities. Because they only invest in highly rated
securities, money market funds offer a high degree of safety Money market funds also offer
Investors higher yields than traditional savings accounts.
Financing in the Money Markets
Q1. The prevailing commercial paper rate on paper issued by large publicly traded firms
is lower than the rate Carson would pay when using a line of credit. Do you think that
Carson could issue commercial paper at this prevailing market rate?
Ans. The risk of default of a commercial paper is influenced by issuer's financial condition and
cash flow. Higher the risk, higher would be the premium required to compensate the excess
risk. The large publicly traded firm is less prone to default so the premium required would be
less. The risk of default by is more as compared to large publicly traded firm so the rare on
paper would be more. So, it cannot issue commercial paper at the prevailing market rate.
Q2. Should Carson obtain funds to cover payments for supplies by selling its holdings of
Treasury securities or by using its credit line? Which alternative has a lower cost?
Explain.

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Ans. If the economy continues to be strong and the market interest rates increases it would
prefer selling its treasury securities since the Increasing market interest rate. causes a notional
loss on the risk-free treasury securities. If it foresees a slow-moving economy, it will cover
payment. of its supplies by using credit line which could be obtained at decreased market
interest rates.
Chapter # 10 Stock offerings and investor monitoring
Point Counterpoint
Should a Stock Exchange Enforce Some Governance Standards on the Firms Listed
on the Exchange?
Who Is Correct?
Ans. Yes, Stock exchange should enforce governance standards on the list of stock exchange
firms to promote general and acceptable trading regulations and policies. These standards are
enforced to ensure that firms perform stock exchange operations fairly and in a consistent
manner. These standards should be based on SEC rules and regulations to administer firms
listed in the stock exchange Proctor and Miles. All stock exchanges taking place through SEC
are subject to intervallic inspection by the commission to ensure that the exchange operates
based on the stipulated policies and rules. These governance standards include reporting of
periodic financial performance and capital structure of the firm
Contemplating an Initial Public Offering
Q1. If Carson issued stock now, it would have the flexibility to obtain more debt and
would also be able to reduce its cost of financing with debt. Why?
Ans. If C Company chooses to issue equity through an IPO (initial public offering), the pod-
up capital of the firm will increase post the issue. Thus, the firm's internal liabilities incase and
affect the Total assets (TA) of the firm positively. This would improve the Total Debt Total
Assets or TD/TA ratio. Put differently, if C Company were to issue stock now, it would be able
to leverage its capital to raise additional debt, up to the debt capacity, when required If C
Company plans a debt issue, it 'rill have to offer a high coupon rate comparable to the yields
corresponding to the period capacity, when required If C Company plans a debt, it will have to
offer a high coupon rate comparable to the yields corresponding to the period of the bond, to
make it attractive to investors and to consider the greater risk involved in long-term investments
Again with the Fed considering options to contain inflation, interest rates will continue to be

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high for some time. The Yield Curve is a graph of yields (or interest rates) of securities against
maturity periods (or time). When a yield curve is upward slope it indicates that long term
interest rates are higher than short term interest rate. C Company also needs to consider the
impact of a debt issue on cash flows, since periodic pay-outs will need to be made for interest
payments Therefore an PO issue would reduce the dependence on costly debt as a means of
financing C Company's expansion and will provide a cushion to raise debt capital in the future.
Q2. Why would an IPO result in heightened concerns in financial markets about Carson
Company’s potential agency problems?
Ans. An agency relationship occurs when an individual or group or company who c called the
principal, hires someone who is called an agent to perform some useful service as required by
the principal The principal delegates the decision-making power up to some extent to the agent
Important agency relationships include between stockholders and the creditors, owners or
managers and shareholders and stockholders and the managers.
Q3. Explain why institutional investors, such as mutual funds and pension funds, which
invest in stock for long term periods (at least a year or two) might prefer to invest in IPOs
rather than to purchase other stocks that have been publicly traded for several years.
Ans. The institutional investors are more interested in investing to IPOs because to take the
gain on the day of listing Ulu, the company coming with IPO during a strong period of the
economy will tend to generate returns for the investors. And as such the prospects of the
company may be strong enough to hue institutional investors to go for it.
Q4. Given that institutional investors such as insurance companies, pension funds, and
mutual funds are the major investors in IPOs, explain the flow of funds that results from
an IPO. That is, what is the original source of the money that is channelled through the
institutional investors and provided to the firm going public?
Ans. The ultimate source of funds is households, individual investors and employers who
contribute to the corpus of mutual funds, pension funds, and insurance companies. Some
investors directly participate in the stock market by buying shares or subscribing to an IPO.
Mutual funds, Pension Funds, and Insurance Companies constitute institutional investors who
also channel funds into the IPO or equity market for gains. Thus, they invest on behalf of
household and share profits with them.

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Chapter # 13 Financial Future Market
Point Counterpoint
Has the Futures Market Created More Uncertainty for Stocks?
Who Is Correct?
Ans. Futures are basically an agreement between the future buyer and seller to provide the
underlying asset i.e., either stock or commodity at a later date. The price for the same is locked
at the futures rate for that particular security called the future.
Future markets are form of derivative market which will be offering with distinct types of future
contracts which will help individual investors to undertake.
Hedging with Futures Contracts
Q1. How could Carson use futures contracts to reduce the exposure of its cost of debt to
interest rate movements? Be specific about whether it would use a short hedge or a long
hedge.
Ans. Carson Company needs funding to finance its operation Its preferred source of raising
finances is commercial loans on which it has to pay floating rate Yield curve is upward and
there is a possibility that economy may slow down Federal Reserve Bank is trying to control
Inflation It would try to increase the interest rate so that activity in economy comes down and
upward pressure in inflation is reduced This may imply that interest rate may go up in the near
future.
Q2. Will the hedge that you described in the previous question perfectly offset the increase
in debt costs if interest rates increase?
Ans. If interest rate in the economy goes up. Carson would have to pay higher rate on its loan
The rate on its floating rate commercial loan would adjust upward Carson can hedge its
exposure to interest rate risk by using interest rate futures. Interest rate futures allow the holder
of the contract to lock into an interest rate payable on an asset The rate payable on asset would
be determined at the time of purchasing the contract The contract would become effective at a
future date.
Q3. Explain what drives the profit from the short hedge, versus what drives the higher
cost of debt to Carson, if interest rates increase.

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Ans. Carson would sell interest rate future in this case. If it sells interest rate future and interest
rate increase. prices of futures contract would fall So Carson would wake a profit on the
contract. At the same time interest to be paid on its liability would go up because of increase
to interest rate Hence. profit made from the interest rate contract would be used to offset the
higher interest rate being paid on its loan. this would help company reduce the increase cost of
funding The Hedge that company is using is short hedge. In between the rate adjustment period,
the cost of loan would remain fixed. Cost of the floating rate loan would be driven by the
benchmark interest rate like Libor on which floating rate adjusts it periodically.
Chapter # 17 Commercial Bank Operations
Point Counterpoint
Should Banks Engage in Other Financial Services Besides Banking?
Who Is Correct?
Ans. Many Banks have expanded their services by acquiring other types of financial
institutions that can provide the services. However, they sometimes pay too much for the
institutions that can offer these services. In general, offering additional services can be
beneficial if the bank does not incur excessive costs from offering these services.
Services Provided by Financial Conglomerates
Q1. Explain the different types of services provided by a financial institution that may
allow Carson Company to obtain funds or to hedge its risk.
Ans. Company C wants one bank to provide all the banking services that it requires Banking
services that a bank can provide fall into two categories Deposit services that create liabilities
for the banks and funding services that creates assets for the bank
Q2. Review the services that you listed in the previous question. What services could
provide financing to Carson Company? What services could hedge Carson’s exposure to
risk?
Ans. From the above-listed services offered by a bank, some of them can protect an
organization's exposure to risk while the others provide the said organization with finances.
Loan commitments put the bank under obligation to give funds in terms of the loan upon
request.

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Chapter # 18 Bank Regulation
Point Counterpoint
Should Regulators Intervene to Take Over Weak Banks?
Who Is Correct?
Ans. Weak banks are a worldwide phenomenon. They pose a continuing challenge for bank
supervisors and resolution authorities in all countries, regardless of the political structure,
financial system, and level of economic and technical development. All bank supervisors must
be prepared to minimize the incidence of weak banks and deal with them when they occur.
Weak banks have common problems. Lessons can be drawn by pooling the experience of
supervisors and resolution authorities, especially the specific actions that have or have not
worked in given circumstances. In the past, the lack of contingency arrangements and
understanding of the tools available for dealing with weak banks have sometimes resulted in
unnecessary delays in supervisory and resolution actions and have been key factors in the
excessive cost of resolving banking problems. The Basel Committee on Banking Supervision
agreed that appropriate guidance could reduce the costs and spill over effects of these problems.
Impact of Regulation and Deregulation on Financial Services
Q1. Explain how the services provided by a commercial bank (just the banking, not the
nonbank, services) to Carson may be limited because of bank regulation.
Ans. Banks have many limitations when it is regulated, they (Commercial Banks) are bounded
to provide fixed line of services and products to their customers or other financial services
companies. For example, Commercial banks, if regulated, cannot open market. Bank regulation
restricts how bank deploy their funds and what businesses they can operate Banks regulate
about how they can lend so that they are able to manage the default risk properly in particular,
there are three types of restriction placed.
Q2. Explain the types of nonbank services that Carson Company can receive from the
subsidiaries of a commercial bank because of deregulation. How might Carson Company
be affected by the deregulation that allows subsidiaries of a commercial bank to offer
nonbank services?
Ans. Financial services regulation act, 1999 allowed holding company of banks to provide
securities and insurance services. This has allowed banks to offer entire gamut of financial
services to the bank or its affiliates. As a result, company like company C can avail of

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nonbanking services from the same bank, which provide them, banking services. Example of
such non-banking services is purchase e of various life and general insurance products,
transactions in equity shares, mutual funds and bonds, advisory services related to issue of fresh
equity and bonds to the public services related to mergers and acquisition etc. This offer
convenience to company like company C does not have to maintain multiple relationships with
multiple entities for various financial needs.
Chapter # 19 Bank Management
Point Counterpoint
Can Bank Failures Be Avoided?
Who Is Correct?
Ans. Banks fail when they are not able to meet the obligations of their depositors and creditors
hence being insolvent. The federal regulators, therefore, close them. Bank failures can be
avoided. If banks focus on providing loans to creditworthy borrowers, most loans will not
default even during recessionary periods. I agree that banks are in the business of providing
credit and that when economic conditions deteriorate, there will be loan defaults, and some
banks will not be able to survive, but this can be dealt with. Banks are in business like all other
companies, and they aim to serve its customers and remain in operation for the longest time
possible.
Bank failures can be avoided by putting in place regulations that safeguard them. Having
regulations that determine the financial investments the banks make would prevent them from
investing in too risky ventures. Bank failures can also be prevented by ensuring that there is a
minimum level of net worth that they should keep, and they should not exceed that. It is also
possible to avoid bank failures by regularly auditing them both internally and externally.
Through these audits, the bank's financial status is identified, and action taken early enough to
prevent failure. Banks can also vet the loan applicants to ensure that they are creditworthy.
Banks should consider the financial status of the applicant, being an individual or an
organization. It should also find the applicant's history of repaying the loans and have thorough
research of the applicant's background. This information will also be used to determine the
maximum amount that the applicant can be given. Through such actions, the bank will remain
a float even in the tough financial periods.

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Managing Credit Risk
Q1. Explain the difference in the willingness of banks to provide loans to Carson
Company. Why is there a difference between banks when they are assessing the same
information about a firm that wants to borrow funds?
Ans. There is a difference in banks’ willingness to offer loans to company D even though they
are looking at the same information. The difference can be explained in terms of ability of the
bank to manage risk. This is internal to the bank and not related to company C.
Some bank has ability to access information and make judgment about the risk inherent in a
business. As a result, it can price different grades of risk. Many of such banks make a portfolio
of higher risk loans. While individual loans given to a company would be risky, this risk would
reduce if a portfolio of such loans are made. Portfolio would have higher default risk than a
portfolio of less risky loans. To cover for the higher default risk, bank would charge higher
interest rate. Such bank would be able to make risky loans also.
Another reason could be that stakeholders of such banks expect bank to take more risk to
generate higher return. The bank may hold more capital, or it may have a better work loan work
out expertise to handle higher risk. Many banks are specialist in handling risky loans. It is
because of these factors that different bank would respond differently even when they have
same information set about company C.
Q2. Consider the flow of funds for a publicly traded bank that is a key lender to Carson
Company. This bank received equity funding from shareholders, which it used to
establish its business. It channels bank deposit funds, which are insured by the Federal
Deposit Insurance Corporation (FDIC), to provide loans to Carson Company and other
firms. The depositors have no idea how the bank uses their funds. Yet, the FDIC does not
prevent the bank from making risky loans. So, who is monitoring the bank? Do you think
the bank is taking more risk than its shareholders desire? How does the FDIC discourage
the bank from taking too much risk? Why might the bank ignore the FDIC’s efforts to
discourage excessive risk taking?
Ans. A bank uses equity from its shareholders and deposits, insured by FDIC, to make loans.
Many a time loans that they make are risky. Many depositors have little idea about risk in the
loan portfolio of a bank. As indicated in earlier part of this problem, many banks have ability
to access information and make judgment about the risk inherent in a business. As a result, it
can price different grades of risk. Many of such banks make a portfolio of higher risk loans.

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Some of such banks have better ability to manage loan portfolio of risky assets. On the other
hand, some other banks are being reckless while making risky loans that they do not have
ability to manage. They are attracted by the higher rate that risky loans offer.
Banks are monitored by several regulators. Regulators would know when a bank is taking
excess risk. Moreover, publicly listed banks would have to make their financial and asset
quality public. Analysts watching the banks and many shareholders would be able to make out
that bank is taking higher risk. Hence several entities and group of persons are monitoring
bank.
If shareholders do not want the bank to take excess risk, they would sell the shares and invest
in less risky bank. Shareholders who are holding share of risky bank would expect higher
return. There are distinct categories of shareholders and some of them may want the bank to
take higher risk to generate higher return.
FDIC would not make blanket rule to discourage banks from taking higher risk. Important
aspect to note is that many banks have ability to manage risky assets. Such banks are also
performing a significant role in economy as someone needs to provide funding to risky
businesses also for economy to grow. FDIC does monitor the banks and their processes and
make recommendations from time to time. Sometimes banks can ignore the advice given to
them by regulators or market participant. They do so out of greed to generate higher profit.
Management of some bank may underestimate the risk of bank’s loan portfolio. They may even
understate it to show better performance. They may do so in the hope of receiving higher bonus
and compensation.
Chapter # 20 Bank Performance
Point Counterpoint
Does a Bank’s Income Statement Clearly Indicate the Bank’s Performance?
Who Is Correct?
Ans. There is some degree of manipulation that is possible for banks, but regulatory oversight
may limit the inaccurate financial reporting. The accounting irregularities in recent years have
been in other industries.
How the Flow of Funds Affects Bank Performance
Q1. Classify each service according to how Blazo benefits from the service.
• Advising on targets that Carson may acquire

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• Futures contract transactions
• Options contract transactions
• Interest rate derivative transactions
• Loans
• Line of credit
• Purchase of short-term CDs
• Checking account
Ans. Classifying service according to the benefit
• Advising on targets that Carson can acquire - Fee based
• Futures contract transactions - Interest Income
• Options contract transactions - fee based income
• Interest rate derivative transactions - interest income
• Loans - interest income
• Line of credit - interest and fee-based income
• Purchase of short-term CDs - fee based income
• Checking account - fee based income
Q2. Explain why Blazo’s performance from providing these services to Carson Company
and other firms will decline if economic growth is reduced.
Ans. If the economic growth is reduced Blaze's performance from majority of these services
will decline. There would be less economic activity due to the slowing growth rate and less
consumption of the services leading to less Income for Blazo and other financial services firms.
However, Income from services like advising on variety of issues/concerns will increase since
more companies will go for realigning strategies to cope with slow growth This would result
in income for financial services firms offering these services.
Q3. Given the potential impact of slow economic growth on a bank’s performance, do you
think that commercial banks would prefer that the Fed use a restrictive monetary policy
or an expansionary monetary policy?

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Ans. During the slow economic environment, the commercial banks would prefer a loose
monetary policy by the Fed. The most important reason is that the amount of funds or the
liquidity in the market would be low because of slowing growth. Commercial banks need funds
to be able to lend them to customer and they raise funds from a variety of sources at different
costs. If the monetary policy is loosed it will provide easy and cheap capital to these banks
which would help improve their performance.

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