Intermediaries that raise large amounts of money through the sale of commercial paper and securitiesUsed to make generally small loans to businesses and households.Three types: consumer finance, business finance, and sales firm finance.Consumer Finance: make loans to enable consumers to buy cars, furniture, and appliances to finance home improvements and refinance household debts.Higher risk of default than good quality bank customers so they are charged higher rates.Business finance: engage in factoring: purchase of accounts receivable of small firms at a discount and then holds the receivables to maturity to earn a profit.Sales Finance: affiliated with companies that manufacture or sell big ticket goods.Promote the business of the underlying manufacturer or retailer.GMAC offers financing to customers when they buy new GM cars.Department stores offer credit cards with customers who shop at stores to finance purchases.Increased their role in consumer and business lending over the years.Contractual Saving InstitutionsAllow individuals to pay money to transfer risk of financial hardship to someone else or to save in a disciplined manner for retirement.Insurance CompaniesFinancial intermediaries that specialize in writing contracts to protect their policyholders from the risk of financial loss associated with particular eventsFees called premiums are used so that the insurance company assumes the risk.Ex. Allstate, Aetna, PrudentialInsurance policies are the worst way to save money for your future. Built into each policy is a mortality expense, and the insurance company decides the Internal Rate of Return (IRR)Two types of insurance: life insurance and property and casualty insuranceLife Insurance: sell policies to protect households against a loss of earnings from disability, retirement, or death of an insured person.2 types: mutual companies—are owned by the policyholders and stock companies—are owned by the shareholders.Issued whole life or term lifeBuy term life insurance instead because there is no cash build upAfter term is over, there is likely no more need for life insuranceCollege funds, retirement, etc should already be built upP&C – Property and CasualtySell policies to protect households and firms from the risks of illness, theft, fire, accidents, or natural disastersInsurance companies profitability depends in large on their ability to reduce information costs of adverse selection and moral hazard.Pension FundsInvest contributions of workers and firms in stocks, bonds, and mortgages to provide for pension benefit payments during workers’ retirementNon-deposit taking intermediariesVesting—the length of service required before an employee is entitled to future benefits and the required amount of time varies among plans.Defined Contribution PlanContributions are invested for the employees, who own the value of the funds in the planTake defined contribution because you are in controlIt is profitable, pension income during retirement will be high and if it is not profitable it will be low.Employee Stock Ownership Plans are invested primarily in employer securities. The value depends on the performance of the firm as measured by the value of the securities.Defined Benefit PlanEmployee is promised an assigned benefit based on earnings and years of serviceMore commonUsed in unionsMay or may not be indexed informationWill be lost if the company goes bankruptIf there is an employer match, take it!Employer matches the amount of money put into the defined contribution planFIN3244 EXAM 4—Bullets1. Securities market institutions: contribute to the efficiency of financial markets through investment banks, brokers and dealers, and organized exchangesThese institutions reduce costs of matching savers and borrowers and provide risk-sharing, liquidity, and information services.Securities market institutions are NOT financial intermediaries because they do not acquire funds from savers to invest in borrowers; they only make it easier for investors to locate suitable borrowers and to reduce borrowers’ costs in raising fundsA) Investment Banks—informationAssist businesses in raising new capital in primary markets, and advise them on the best way to do so1st way: Investment bankers earn income through underwriting a firm’s new stock or bond issueUnderwriters guarantee a price to the issuing firm, sell the issue at a higher price, and keep the profit (aka spread)In exchange for spread, underwriting investment bank assumes risk of not being able to resell securities2nd way: Investment bank can also sell the issue on an all-or-none basisIn this case, the company issuing the securities receives nothing unless the investment bank sells the complete issue at the offering price3rd way: best efforts: Allows the investment bank to make no guarantee, requiring it to sell to investors only as much of the issue as it canSmall issues may be underwritten by a single investment bankerLarge issues are sold by groups of underwriting investment banks called syndicatesSyndicated sale: lead investment bank acts as manager and keeps part of the spreadRemainder of spread is split among the syndicate members buying issue and to brokerage firms selling issue to publicUnderwriting lowers information costs between lenders and borrowers because investment banks put their reputations behind the firms they underwriteIn the 1980s, investment banks engaged in merchant banking—they placed their own funds at risk by investing in firms that were undergoing restructuringB) Secondary Markets—liquidity and risk sharingi.) Brokers and dealersfacilitate the exchange of securities in financial markets by locating buyers when sellers want cashdecrease in time and cost required in secondary markets improves liquidity in those marketsBrokers: earn commissions by matching ultimate buyers and sellers in a particular marketDealers: trade between ultimate buyers and sellers; they hold inventories of securities and sell them for a higher price than they paid for them, earning the spread between the bid and asked priceSEC regulates brokers and dealers to ensure disclosure of info, prevent fraud, and restrict trading based on insider informationii.) ExchangesSecurities may be traded in one of two ways: through exchanges or in over-the-counter marketsExchanges: physical location at which securities are tradedDon’t set prices but provide way for buyers and sellers to trade anonymously, lowering info costs for
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