1 Fin3244 Test 1 Financial Crisis 2007 2009 Originated in the housing industry which experienced an unsustainable increase of price or bubble during the years of 2000 2005 Changes in the mortgage market which allowed for their securization and sale on a secondary market allowed lenders to extend loans to riskier borrowers in a originate to distribute business model The bubble pops during 2006 2007 and borrowers defaulted on their mortgages in a large enough scale to cause sharp drops in the value of mortgage backed securities Government sponsored enterprises handling the mortgages Fannie Mae and Freddie Mac Investment banks such as Lehman Brothers and insurance companies such as AIG begin to fail which results in a series of bailouts Firms experienced huge losses as the share price of securities fell throughout the crisis Borrowers now face much stricter credit standards from commercial banks and other financial intermediares SEC investigated many investment banks for fraud and other charges involved with complicated derivative trades known as CDO s collateralized debt obligations Present value Future value Due to inflation risk of default and opportunity cost future payments are worth less in the future then they are today Discounting future payments is necessary to determine their value today General Discounting concepts The longer the amount of time to a future payment the less valuable it is in the present As the interest rate used to discount future payments increase the present value of the future payment declines In a series of future payments the present value is the sum of the discounted value of the individual payments Future Value The value at a future time of an investment made today Present Value the value today of funds that will be received in the future Time Value of Money the way that the value of a payment changes depending on when the payment is received Discounting process of finding the present value of funds that will be received in the future 2 Future Value Formula FVn Principal x 1 I n FVn Future value in n years I interest rate N number of years Present Value Formula PV FV 1 I n PV Present value or Present discounted value FV Amount of a future payment I Interest rate N number of years until payment is received Features of Financial Markets Places Channels for buying and selling stocks bonds and other securities Trading takes place electronically or over the coutner Financial markets provide risk sharing liquidity and access to information Two Types of Markets Primary and Secondary Primary Markets market in which stocks bonds and other securities are sold for first time E G Stocks have initial public offerings IPOs this occurs in primary markets Secondary markets market where investors buy and sell already existing securities The securitization of mortgages and other loans allowed them to be traded on secondary markets Bond Market buying and selling of existing bonds Because bonds are fixed rate market interest rates determine their value Increases in interest rate causes decline in value while decreases in interest rate causes increase in value Monetary Policy Actions the federal reserve takes to manage money supply and interest rates Federal Open Market Committee FOMC main policy making committee of Fed o Decides of target for Federal Funds Rate the inter bank interest rate for loans Financial Intermediaries financial firms such as banks that borrow funds from savers and lend them to borrowers Customers lenders deposit funds into bank and bank loans them to other customers borrowers Commercial banks are most important financial intermediaries Others include credit unions savings banks hedge funds investment banks insurance companies pension funds and mutual funds 3 Commercial Banking Sources and uses of funds are summarized on balance sheet a statement showing an individual or firms financial position at a specified point in time Balance sheet Assets Liabilities Shareholders Equity Banks impact community by helping finance households and improve national and local economy by financing small to medium size businesses For Commercial Banks Liabilities checkable deposits non transaction deposits and borrowings Checkable Deposits accounts from which depositors can write checks o Ex Demand deposits NOW deposits negotiable order of withdrawal Non transaction deposits accounts which depositors do not have immediate access to o Ex Savings Accounts Money Marketing Deposit Accounts and Time Deposits or CD s certificate of deposits Borrowings short term loans in federal funds market other banks discount loans from Federal Reserve System and repurchase agreements o Repurchase Agreements Repos banks sell securities to other banks and firms under an agreement to repurchase them usually the next day Allows very short term acquisition of funds o Discount Loans Federal reserve acts as lender of last resort by providing discount loans to banks suffering from short term liquidity problems Assets Reserves and other cash assets securities loans and other assets Reserves and cash assets vault cash reserves or cash on hand in bank or in other banks and bank deposits with federal reserve o Required reserves reserves required by Fed to be held against demand deposits and NOW account balances o Excess reserves and reserves held above amount necessary to meet Securities liquid assets bank trades on financial markets sometimes called secondary reserves due to their liquidity o Ex Investment grade corporate bonds US Treasury Bills and requirement municipal bonds Loans any loans extended to businesses consumers households and real estate loans o Are illiquid relative to securities and contain greater default risk and higher information cost o Real estate loans make up largest percentage of total loans Other Assets physical assets such as equipment and buildings Bank Capital AKA shareholders equity or bank net worth Assets Liabilities 4 Is sum of contributed capital from shareholders and retained earnings Was 12 of total bank assets in US during 2010 Checkable Accounts Demand deposit accounts o Must be paid by bank on demand immediately o Are Liabilities to bank because banks must pay back to depositors on demand NOW Accounts Negotiable order of withdrawal o Checkable accounts that pay interest Non Transaction Accounts Savings Accounts originally called passbook accounts o Technically require 30 days notice of withdrawal but banks usually waive requirement Money Market Deposit
View Full Document
Unlocking...