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Finance CompaniesIntermediaries 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 planTest 4—Notes Beginning April 3, 2012Chapter 12I. What financial Institutions Do?o Security Markets Institutions Investment banks, brokers, dealers and organized exchanges Reduce the costs of matching savers and borrowers and provide risk sharing liquidity and information services that enable financial marketsto function smoothly.  Not financial intermediaries because they do not acquire funds from savers to invest in borrowers.o Investment Bank Goldman Sachs (Broker-Dealer) Merryl Lynch - Like baseball—t-ball and the pros.  They have the same physics, but are clearly different.  Bank of Tallahassee—have a broker dealer, but hardly the same as Goldman Sachs- Don’t have the same investment arm- It could be outsourcedo Investment banking institution: what are they doing?  They are involved in underwriting Good thing to have, but expensive- Look into value of company- Assessing the risko Manages peoples money—investment advisoro Investment institution: Investment fund Mutual fund Different services on o Commercial Savings Institution A bank  Credit Uniono Contractual V. Depository Saving Institutions Contractual: bound to make a series of payments to reap the benefits- You have agreed to something in writing Depository: commercial banks, savings and loan associations, mutual savings banks, credit unionII. Underwritingo ** Underwriting  securities institutions  assessing risk investment bankers do this. o Investment banks assist businesses in raising new capital in primary markets and advise them on the best way to do so: either by recommending a stock issue or by structuring debt contracts to attract investors. They do this by underwriting a firms new stock or bond issue. Underwriters guarantee a price to the issuing firm, sell the issue at a higher price and keep the profit or spread. In exchange for this the underwriting investment bank assumes risk of not being able to re-sell the securities.  If investment banker is involved and underwriting is involved you are in the PRIMARY market, being born. Secondary it’s already there. Underwriting lowers the information costs between lenders and borrowers because investment banks put their reputations behind the firms they underwrite.  Example: I’m going to give you a million dollars giving you my best effort. Your confidence is pretty high to listen to this. - Best efforts: who is in control of satisfactory in the agreement, it is the person telling you that you are relying on. - When someone else is involved in your happiness. Not good. You want to be in control of your own outcome. You do not want to be in the “Hope” category, hoping that things will workout. - Best effort implies no particular agreement that you will do something. It is like selling something for consignment. - Underwriting value not the firm itself  Financiers used investment banks to


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FSU FIN 3244 - Test 4—Notes

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