Final Exam Study Guide Chapter 12 14 19 and 20 20 Question Final Securities Market Institutions Financial Intermediary Asset Size pg 423 table 2 1 pg 423 425 Securities market institutions are financial institutions not financial intermediaries in particular investment banks brokers and dealers and organized exchanges that contribute to the efficiency of financial markets by reducing costs of matching savers borrowers done by investment banks and providing risk sharing liquidity and info services done by broker dealers and exchanges Financial Intermediaries acquire funds from savers to invest in borrowers In easy terms they basically invest in stocks mortgages etc and use the profits to in turn again invest in borrowers Investment institutions mutual funds and finance companies contractual saving institutions insurance companies and pension funds depository institutions commercial banks savings institutions credit unions and govt financial institutions are all Financial intermediaries Following is financial intermediary asset sizes in millions from 2006 in table 2 1 Money Market mutual funds 2014 other mutual funds 674 finance companies 1300 life insurance companies 4479 property and casualty companies 1280 private pension funds 4876 state and local govt retirement funds 2791 commercial banks 9528 savings institutions 1829 credit unions 703 govt financial institutions 2829 These assets total of 38 4 trillion Commercial banks hold the largest of total assets of intermediaries at 24 8 pg 424 These institutions basically assist businesses in Finance companies are intermediaries that raise large amounts of money through the sale of commercial paper and securities and then use that money to make small loans to households and businesses Investment bank functions 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 One of the means of income for investment bank is through underwriting a firm s new stock bond issue They do this by guaranteeing a price to issuing firm selling the issue at a higher price and keeping the profit known as spread The spread basically is payment to the bank for taking the risk of not being able to resell the securities to investors Large issues of underwriting are sold by groups of investment banks known as syndicates Underwriting lowers info costs between lenders and borrowers because investment banks put their reputations behind the firms they underwrite Risks of underwriting bond issues are positively related to volatility of interest rates There are variances to underwriting for e g if it s a risky new security issue the bank may not be able to guarantee the price So rather than guaranteeing a price the bank may sell the issue in an all or none basis security issuing company receives nothing unless bank sells complete issue at offered price or a best effort basis bank makes no guarantee requiring it to sell to investors only as much of issue as it can Investment banks in 1980 s also engaged in merchant banking placing own funds at risk by investing in firms that are undergoing restructuring Junk Bond characteristics Types of securities markets pg 427 there are two types of securities markets pg424 Junk bonds are bonds with ratings of less than and investment grade Baa moody s investor services or BBB standards poor s because of it high risk of default Also known as high yield bond or speculative bond Typically offer interest rates 3 4 higher than safer govt issues They however typically pay higher yields than better quality bonds exchanges or over the counter markets And exchange is a physical location where securities are traded So it is basically an auction market where assets are bought for lowest price from offerer and sold to bidder of highest price exchanges however don t set the prices Buyers and sellers are matched on floor of exchange by a broker dealer specialist representing 1 or more stock Best known exchanges are NYSE and American stock exchange AMEX Size of issuing firm determines which exchange it is listed on In Over the counter markets telephone takes place over telephone computer The SEC fostered development of a consolidated arrangement for trading securities the national market system NMS where broker dealers regulate themselves through the national association of securities dealers NASD The NMS provides computerized quotes through NASDAQ Merging of NASD and AMEX in 1998 yielding a firm with both auction market and over the counter banks are not as large by international standards 46 have less than 100 million in assets Citigroup and Bank of America are 2 banks in top 10 in world US have enormous number of banking firms currently about 25 banks million people The bank industry is far less concentrated compared to international standards This however only means the US have more separately owned banking firms per capita and doesn t mean that US receives more banking service compared to international standards Govt regulation and regulatory changes are the primary reason for the differences in US banking industry The US has a dual banking system commercial banks are chartered and examined both pg 452 453 US has world s largest economy however US U S Banking characteristics CAMELS Bank Run pg 455 Regulators use examinations to monitor compliance of banks with starting pg 456 if a bank is not doing good depositors lose confidence in a by the fed and by the states Regulatory agencies that are responsible for commercial bank regulation include the Federal deposit insurance corp FDIC office of comptroller of the currency the fed reserve system and state banking authorities Fed chartered banks are known as natnl banks and state chartered banks state banks A demand deposit is a close substitute for currency adopted by nantl and state banks it is an account against which checks convertible to currency can be written capital standards and restrictions on permissible activities After examination banks receives grades in the form of C capital adequacy A asset quality M management E earnings L Liquidity and S sensitivity to market risk A sufficiently low CAMEL rating can lead to cease and desist orders to change behavior a means of restraining moral hazard Such a system mimics the way private markets approach moral hazard by inserting restrictive covenants in financial contracts bank Spreading of bad news called contagion whether true
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