Finance 301 1st Edition Lecture 17 Outline of Last Lecture I Money Market Funds II Other Types of Funds III Performance of Mutual Funds IV Valuation of Bond Mutual Funds Outline of Current Lecture I II III IV Background on Commercial Banks Bank Sources of Funds Uses of Funds by banks Off Balance Sheet Activities Current Lecture I Background on Commercial Banks a Interstate banking regulations 1994 So the number of banks are increasing or decreasing over time i 1985 top 100 banks had 50 percent of countries money ans assets but as of mid 2000s top 100 banks had about 75 percent of our money and assets banks have been getting larger in size but smaller in number and acquisitions ii 1994 banks start buying other banks merging to become smaller number of banks decreased but sizes got bigger iii Financial conglomerates multiple businesses commercial investment and sell insurance all at the same time Commercial mainly loan money investment banks invested in peoples money They don t sell real estate yet Government is not letting them do everything yet this is good and bad good because it is convenient get everything done at one place but there is nothing specialized and there are less options for the customers the little guys have to compete with banks that are too big to fail II b Bank holding companies generally own 10 or more of the bank and provide flexibility with the following example regions bank or regions financial corp banks have to borrow money because they need to meet their obligations pay interest on different savings and checking accounts i Short term debt ii Stock issuance iii Stock repurchase iv Acquisitions c Bank Sources of Funds a Transaction Deposits i A demand deposit account first place they get their money fancy name for checking accounts ii Conventional demand deposit write unlimited checks iii Negotiable order of withdrawal NOW account they pay interest on a NOW account have to have a minimum balance They want money to loan out b Electronic Transactions Direct deposit online banking Bill Pay transfers between accounts deposit checks ATMs c Savings Deposits i Passbook savings account carry a passbook and stamp it when you took money out and put money in ii the difference is you cant write checks pay you an interest on this can not just get money out everyday d Time Deposits i What is this 1 CDs and NCDs you have to keep this money in the banks a certain amount of time to get your money back and some more money market investment year or less cant write a check on it e Certificates of Deposit i The difference between the two is the amount of money we can get a CD but NCDs are what companies used and these can be sold to investors usually 100 000 or more f Negotiable Certificates of Deposit g Money Market Deposit Accounts i Differ from conventional time deposits in that they do not specify a maturity What are the differences as compared to savings accounts 1 Can earn interest used by investors that are investing in stocks and bonds to the banks they have to have a minimum balance usually about 10 000 Can write very few checks on investing accounts III h Federal Funds i How long do banks borrow on this market or at this rate 1 Less that a year ii Why do banks borrow here 1 Need to meet reserve requirements which is 10 iii What is this rate now And why does this number matter 1 The rate now is between 0 to 0 25 generally the lowest rate sets the bottom for interest rates This number matters because it sets the floor for interest rates in our country i Borrowing from the Federal Reserve Banks i What is this rate called What is the discount window 1 Discount rate Called this because they borrow the discount window Go to fed at their discount window and borrow money j Why borrow from the Fed i Borrow from the FED instead of borrowing from another bank because of safety cant find a math from another bank just go to the government k Eurodollar Borrowings i May borrow dollars from those banks outside the United States typically in Europe that accept dollar denominated deposits or Eurodollars ii Bank can borrow over seas if they want to they do not really do this a lot because of the exchange risk NOT COMMON l Bonds Issued by the Bank i Banks often issue corporate bonds Why would they need these bonds Bond is long term debt 10 30 years banks borrow long term debt here real estate building things of that nature m Bank Capital i Represents funds acquired by the issuance of stock or the retention of earnings These are to absorb operating losses ii Cash they make also they get money by issuing stock n Uses of Funds by banks a Cash i Why do banks have to hold cash in the vault 1 Reserve requirement they do not have to hold it all in the vault they can hold it in federal reserve vault because then they can be less robbery security risk this did not happen until 2008 ii Why does not all cash have to actually be in the vault 1 Reserve requirement hold around 15 20 iii Why do they not hold much more cash than the minimum requirement 1 They do not hold any more than they need to because they want to loan it out and make interest on it If they loan it out they will make higher interest Hold more than 10 because you will have more cash to stay above the reserve requirements just to pay your liabilities b Bank Loans i Types of Business Loans 1 Working capital loan designed to support ongoing business operations 2 Term loans primarily to finance the purchase of fixed assets such as machinery and real estate Generally called balloon notes Most loans to banks are this This means you borrow money for 20 to 30 years but it balloons after 5 years This means they start the loan again with the new interest rate This is called an interest rate risk The banks do not want to hold your mortgage What they want is short term loans Balloon are mostly like things on your car or a second mortgage 3 Line of credit allows the business to borrow up to a specified amount at differing times They let you get money at different times They advertise these a lot because rate varies it floats adjustable changes with the market less risk for the banks c Loan Participations i What is this What is it for Banks work with other banks to loan money Two or more banks work together to loan money Huge projects such as apartment complexes financed by they want someone else to have to risk of default as well ii Prime rate Benchmark interest rate charged by banks iii Is this higher or lower than other rates we have