Financial Markets and Institutions – BA 543Chapter 2 – Financial IntermediationSlide 3Slide 4Slide 5Slide 6Slide 7Slide 8Slide 9Slide 10Financial Markets and Institutions – BA 543Thursday Bexell 41512:00 noon to 2:50 p.m.6:00 p.m. to 8:50 p.m.Chapter 2 – Financial IntermediationDefinition of Financial IntermediationTransforming financial assets into more widely preferred type of asset/liabilityExample: Car LoanExample: Swap (Bond swap from fixed to floating rate)Performed by Financial InstitutionsMany of these intermediation functions are completed with large institutionsCompleted in Financial MarketsChapter 2 – Financial IntermediationA closer look at Financial InstitutionsTypesBanks – Commercial, Investment, Savings and Loans, Credit Unions, etc.Investment CompaniesInsurance CompaniesOthers – Pension Funds, Foundations, etc.FunctionsTransforming, Exchanging, and Designing Financial AssetsAdvising and Managing Financial AssetsChapter 2 – Financial IntermediationDirect Investing with IntermediariesCommercial BankDirect Deposit – CD – Promised Payment at the end of the Investment PeriodDollars are loaned to a borrower (to buy a car) with a different payment scheduleIndirect Investing with IntermediariesMutual Fund Company (Investment Company)Buy mutual fund shares at NAV (no load)Company uses funds to buy stocks and bondsChapter 2 – Financial IntermediationFour Functions of IntermediationMaturityBorrow in the long, lend in the shortRisk Reduction (Diversification)Eliminate firm specific risk via a portfolioCost Reduction of Information/ContractingShare information acquired across large set of individualsPayment MechanismsChecks, Credit Cards, Debit Cards, etc.Chapter 2 – Financial IntermediationAsset/Liability Management for Financial InstitutionsNature of Business – Buy and Sell MoneyBuy Low, Sell High – SpreadNature of LiabilitiesTiming and Amount of Outflow of CashTable 2-1 Page 19Liquidity of Claims against Financial Institutions – can obligations be met with current assets of the institution?Chapter 2 – Financial IntermediationGrowth of Financial Intermediaries through Financial InnovationMarket Broadening Instruments – attracts new investorsZero-Coupon Bonds – TGIRS, LYONS, etcRisk Management Instruments Options Arbitrage Instruments – Price StabilityIndex Assets for direct tradeMotivation? Risk Transfer or ArbitrageChapter 2 – Financial IntermediationAsset SecuritizationPledging Cash Flows from a set of borrowers to the lenders of the funds…Example Mortgage Backed SecuritiesGinnie Mae, Sallie Mae, Freddie Mac…Conforming Loans are the security for the Bonds sold to investors and the payment of the mortgage payment flows to bondholdersOriginal Lender to Mortgage does not service loans – just pools loans and sells bondsCosts and Benefits? Implications?Chapter 2 – Financial IntermediationEnd of Chapter Questions#7 – Mutual Funds – Advantages and Disadvantages for InvestorAdvantagesRisk Reduction – Portfolio Cost Reduction for information and transactionsRecord KeepingDisadvantagesLoss of flexibility for individual investorPay gains annually stock appreciationConclusion – Meets the needs of many investors thus the growth…Chapter 2 – Financial IntermediationEnd of Chapter Questions#8 – Volatility Increases InnovationGreater Volatility means Greater RiskGreater Risk means Benefits of Risk Transfer IncreasesFinancial Innovation is finding an efficient way to transfer risk so greater volatility increases the benefits of new ways to transfer risk.#10 – Asset Securitization and LiquidityLiquidity of Market (instruments have a secondary market)New Lenders that find “niche” meets their
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