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30 Cards in this Set
- Front
- Back
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4 Functions that Financial Markets Perform for the Canadian Economy and Society |
- raise long-term capital funds for fixed assets and infastructure expansion, and allocate society's saving among DSUs - collect and channel short-term funds to companies to finance current production and inventory accumulation - transferring the ownership of financial instruments - source of continuous valuation signals |
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3 Conditions that define Allocative Efficiency within Financial Markets |
- throw up signals - credit is available at the same cost to all equally-creditworthy borrowers, therefore higher yields for higher risk - market prices, interest rates, and other valuation signals reflect all currently-available public information in such a way to equate the demand and supply of securities |
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Primary Market Transaction |
exchange of securities for cash happens directly between SSUs and DSU |
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Secondary Market Transation |
existing securities can be bought or sol, usually with the help of a broker |
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Brokerage Function |
brokers provide continuous availability and valuation information about securities, and they arrange for the efficient transfer of ownership of securities |
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Financial Fiduciary |
mark investment decisions and manage asset-side portfolios for their clients |
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Denomination Intermediation |
allows small savers to circumvent the lumpiness and invisibilities often associated with primary securities |
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Credit Risk Intermediation |
diversification of risk and default risk is minimized through (a) the subordination of the FI's capital base to depositors in liquidation and (b) the presence of various government guarantees and supports |
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Maturity Intermediation |
transform the maturity of a primary security into indirect securities with different (usually shorter) maturities |
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Banker's Risk |
the risk that a FIs cash and LA (liquid asset) holdings and its concurrent cash inflows will provide to be sufficient to meet the withdrawl requests of its depositors and other commitment and payment obligations as they come due |
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Public Financial Market |
FA (financial asset) prices are determined by the simultaneous joint bidding of large numbers of buyers and sellers |
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Private Financial Market |
special FAs (financial assets) are structured and priced in a private negotiation between borrower and lender |
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Macro Liquidity |
willing to provide deposits |
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Market Liquidity |
liquidity in trading your stocks, your trading doesn't affect prices |
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Balance Sheet Liquidity |
liquid assets to satisfy withdrawl demands |
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Discretionary Balance Sheet Item |
assets and liabilities over whose level - but not rate - the FI has considerable short-run control (discretionary - ability to alter the level) |
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Non-Discretionary Balance Sheet Item |
assets and liabilities whose level the FI has little or no control in the short run (demand deposits) |
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LAs (liquid assets) tend to have the following characteristics: |
1. a short term to maturity/duration 2. fixed or highly-predictable income 3. negligible credit/default risk 4. continuous, visible market valuations 5. large trading volumes 6. very narrow bid-ask spreads 7. marketable in large blocks at very low cost 8. bought and sold by a wide variety of investors and FIs 9. a tendency to have lower yields than longer-term, risky securtities |
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Reasons a FI would Hold Lower-Yielding Liquid Assets on the Asset Side of its B/S |
1. to meet minimum reserve requirements 2. to store investible funds to support the future growth of non-LA lending 3. for asset-side diversification purposes 4. to take advantage of asset-liability hedging opportunities 5. speculative demand for LAs 6. in order to build confidence among the FI's depositors 7. to meet unexpected deposit withdrawls and reduce banker's risk 8. to shorten the average term to maturity (duration) on the asset side of their B/S 9. to reduce the transaction costs associated with their portfolio adjustments 10. hold LAs in inventory prior to their resale to other FIs and the investing public |
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Contagion Risk |
the risk that one FI's difficulties with a class of assets, a type of contractual arrangement, or a securitization vehicle causes difficulties for another FI by associations, and not because there is any fundamental problem with the second FI's assets, contracts, or securitization vehicles |
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Liability Management |
manage the inflow of money |
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New capital raising opportunities for the banks included the following: |
1. common equity issues no longer had to be by means of public rights issues 2. could issue preferred shares 3. could issue convertible shares 4. were permitted to denominate their equity and debt issues in currencies other than Canadian dollars 5. percentage-share-ownership restrictions were made more flexible |
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Revolving Loan |
one where the amount outstanding under the credit arrangements varies up and down over time at the borrower's discretion, subject to observing some maximum, pre-arranged credit ceiling |
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Project Financing |
loans are secured by the assets and cash flows of a specific project, and the bank lender usually has little or no recourse to the project's sponsor to make good on loan servicing payments if the project defaults on its obligations |
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Syndicated Loan |
an arrangement whereby a large bank makes a loan to a corporate customer and then this lead bank turns around and sells "participations", or pro rata shares, in this loan to other banks and FIS |
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Multiple-Option Facility |
a syndicate of banks makes a medium-term commitment to provide a corporation with financing, when requested, at a set spread above LIBOR or some other agreed-upon rate. In return for their commitment, the banks receive a fee whether or not they are called on to lend |
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Cost-of-Funds-Based Rates |
are rates that are based on the lending bank's own cost of raising funds in the money market, for the same term as the requested loan, plus a mark-up to reflect the borrower's creditworthiness and the competitive conditions in the lending market at the time the loan is negotiated |
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Why Consumers Loans are a Favoured Asset Class for Banks and Other Depository FIs |
1.they carry relatively favourable interest rates, which earn "excess returns" for the lending FI 2. build long-term relationships and cross-sell other products 3. requires only a relatively simple standardized credit assessment, lending decision requires less expertise 4. traditionally had relatively short maturities from 1-5 years, which matched nicely with maturity profiles of the liabilities of most FIs 5. provide a relatively large, steady and predictable inflow of funds over time, enhances the FI's liquidity position 6. offer the opportunity for wide diversification and reduce overall loan portfolio risk 7. demand isn't highly sensitive to the level of consumer loan rates or cyclical fluctuation in these rates 8. consumer credit borrowers can be attracted by advertising and product-design features and other forms of non-rate competition, precisely because such borrowers are not especially rate conscious 9. administrative costs are susceptible to reduction through the application of technology and can be offset by annual fees or per-transaction fees 10. some types of consumer lending can be collected, pooled, and repackaged for sale to investors in the form of ABSs |
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The Attractions of Residential Mortgage Lending for Banks and Other Depository FIs |
1. earn interest and fee revenues that are both (a) competitive with other longer-term, fixed income investments and (b) relatively secure 2. build longer-term relationships with its customers and cross-sell them other loan, deposit, and service products 3. the documentation and credit assessment process for authorizing is relatively standardized and, once the loan is finalized, little subsequent monitoring is required by the lender as long as mortgage payments are not in arrears 4. a large mortgage portfolio generates significant and relatively stable principal repayment and interest inflows, which contribute somewhat to the FI's liquidity 5. residential mortgages can be offered with a variety of terms (to rate renegotiation) to match the term characteristics of the FI's liabilities, and the flow of mortgage business at each term can be managed by adjusting the rate structure 6. wide diversification and overall risk reduction within the mortgage portfolio 7. borrowers can be influenced by innovative mortgage design features and by advertising and other promotions 8. no capital backing requirements for NHA-guaranteed loans and only one-half as much capital backing for other residential mortgage loans 9. due to standardization, FI lenders have been able to collect, pool, and repackage residential mortgages for resale to investors in the form of MBS, enhanced the liquidity of the lenders' B/S 10. providing Canadians with adequate housing has been one of the highest social priorities of the federal and provincial governments |
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Disadvantages for getting involved in Residential Mortgage Loans |
1. forward commitment risk, FI loses the opportunity to charge a higher rate if rates rise during the commitment period 2. repayment risk, when interest rates fall, borrowers have the right to repay some or all of their loans at various times prior to the expiry of the loan term 3. the number of housing starts and resales and the associated volume of mortgage lending are fairly sensitive to the level of mortgage rates 4. FIs making residential mortgage loans have also faced anti-FI-lender legislation in some Canadian provinces 5. there is a significant amount of systematic default risk in residential mortgage lending |
