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35 Cards in this Set

  • Front
  • Back
what types of financial intermediaries are there (name 5)?
commercial banks, saving and loan associations, investment companies, insurance companies, pension funds
what are the three main innovations in finance?
1. sophisticated telecommunication
2. globalization of business + finance
3. securitization- pool traditional assets and sell securities backed by these loan pools in the capital markets
what services do financial institutions provide (6)?
1. transform financial assets acquired in market and constitute them into a type of asset (think commercial bank where people deposit money that becomes the bank's liability)
2. exhange of financial assets on behalf of customers; broker/dealer
3. exchange of financial assets for own accounts; broker/dealer
4. create assets for customers, then sell them to other market participants (underwriting)
5. provide investment advice to other market participants
6. manage the portfolios
name 7 depository institutions.
1. commercial banks
2. savings and loan associations
3. savings banks
4. credit unions
5. insurance companies
6. pension funds
7. finance companies
what is a captive finance company?
nonfinancial enterprises create subsidiaries that provide financial services for its customers
what are direct investments?
financial intermediaries get money (liability) and then invest it in loans or securities- which become their assets
what are indirect investments?
market participants who give their money to financial intermediaries that go on to invest it are making indirect investments
what does a commercial bank do?
accepts deposits and uses proceeds to lend funds to consumers and businesses
what does an investment company do?
pools the funds of market participants and uses those funds to buy a portfolio of securities- stocks and bonds; investor recieves equity- a pro rata share of the outcome of the portfolio
financial intermediaries transform financial assets making these assets more preferable to society. how (4)?
1. providing maturity intermediation
2. reducing risk via diversification
3. reducing the costs of tracting and information processing
4. providing a payment mechanism
what is the benefit of maturity intermediation?
1. investors have more choices concerning maturity for their investments; borrower has more choices for when they have to pay their debt
2. borrow pays lower longer-term rate on loans than if an individual investor offered it b/c bank can count on successive deposits
what is diversification and its benefit?
transforming risky assets into less risky assets; investors with a small sum of funds cannot invest in a large number of companies like an investment company can
how do financial intermediaries reduce the costs of contracting and information processing?
financial intermediaries have economies of scale in contracting and processing information because of the amount of funds they manage; tough for an individual to write a loan contract, acquire information necessary to invest (think opportunity cost, enforcing contract cost, information processing cost, contracting costs)
how do payment mechanisms benefit individuals?
financial intermediaries allow people to make payments without the use of cash- this is critical for the functioning of a financial market
what is the difference between a credit card and a debit card?
credit card- bill at the end of the month
debit card- money immediately withdrawn
why are depository institutions considered spread businesses?
because there objective is to sell money for more than it costs to buy money
what institutions are considered spread businesses and which are not?
commercial banks, life insurance companies (to a certain extent property and casualty insurance)
not spread-
pension funds (do not raise funds themselves in the market)
investment companies (no explicit costs for funds, no liability obligations unless investment company agrees to repurchase shares)
what do the liabilities of a financial institution mean?
the amounbt and timing of the cash outlays that must be made to satisfy contractual terms
how many types of liabilities to financial institutions have?
what is a type-1 liability?
amount of cash to be payed is known
timing of payment is known
depository institutions + insurance companies can sell them
ex: liability forces financial institution to pay $50,000 six months from now
what is a type-2 liability?
payment is known
date of payment is unknown
ex: life insurance policy- payed upon death
what is a type-3 liability?
payment is unknown
date of payment is known
ex: depository institution issues a CD (certificates of deposit); with a floating-interest rate and a stated maturity
what is a type-4 liability?
payment is uncertain
date of payment is uncertain
ex: automobile/home insurance policies; pension plans (depend on when you retire; how much you earn a year)
what three financial innovation categories does the Economics Council of Canada classify?
1. market-broadening instruments: increase liquidity and availability of funds
2. risk-management : reallocate risk
3. arbitraging instruments and processes: allows investors and borrowers to take advantage of differences in costs and returns between markets
what five financial innovation categories does the Bank for International Settlements classify?
1. price-risk transfering innovations
2. credit-risk transfering instruments
3. liquidity-generating innovations
4. credit-generating instruments
5. equity-generating instruments
what two classes of financial innovation does Stephen Ross classify?
1. new financial proucts (financial assets and derivative instruments) better suited for circumstances of time (inflation)
2. strategies to use these products
what are the two conflicting views on financial innovation?
1. avoiding regulations
2. more efficient ways of distributing risk
Causes of financial innovation?
1. increased volatility of interest rates, inflation, equity prices, exchange rates
2. advances in technology
3. more sophisticated/better trained participants
4. financial intermediary competition
5. incentives to get around regulations
6. changing global patterns of wealth
what is asset securitization?
pooling of loans to create sellable securities backed by loans; make illiquid assets (contracts) sellable; more than one institution is involved; commercial bank does not have to absorb credit risk, service the loan or provide funding
what are the benefits to issuers of asset securitization?
1. cheaper funding sources through diversification
2. management of regulatory capital; manage risk
3. generates servicing fee; by selling the security it creates a new fee without having to increase its capital base
4. management of interest rate volatility; can securitize assets that expose institutions to volatile interest rates
what are the benefits to investors of asset securitization?
1. backed by pool of loans
2. credit enhancement; less risk
what are the benefits to borrowers of asset securitization?
1. more liquid assets to sell
2. competition lowers prices
what is denomination intermediation?
transfering very large assets in divisible ones; allows bank to make large loans financed by small dollar investors
what is off-balance sheet financing?
bank does not need its own assets to finance credit
what is a social benefit of asset securitization? example.
1. viatical settlement- allows say an AIDs patient to sell his life insurance policy