Outline Chapter 5 Commercial Banks How and what do banks do Take in deposits and make loans Whom do they typically deal with Regular people like you and me and small businesses What kind of money problems can this cause Mismatched loans Issuing long term loans expecting to not need the cash now but then bank runs cause the bank to have a shortage of cash which they need now Liquidity problems Bank runs everyone trying to take out their money at the same time Bank runs contagion Bank run when everyone who has money in a bank tried to withdraw all their money at the same time Contagion economic problems in one facet affecting the economy of another In this context it is when a bank run spurs several other bank runs Issuing a loan to a person who has bad credit and may not be able to Adverse select problems o Moral hazard problems pay it back back When a person takes out a loan without any intention of paying it o Great Depression banks FDIC Federal Deposit Insurance Corporation Insures the deposits made to commercial Monitoring The FDIC monitors the compliance of banks according to regulation o Unintended Consequences Too big to fail Protection of non bank intermediaries Investment Banks Understand activities Compare contrast with commercial banks Terminology Money markets Greatest growth of all mutual funds High quality short term Treasury bills and commercial paper Capital markets Markets of long term securities such as stocks and bonds Proprietary trading When the firm uses its own money to invest and thereby make more money 1 Repurchase agreements repos The firm makes a loan of a treasury bill in exchange for capital they then buy back the tbills at an agreed upon HIGHER price which serves as the interest on the loan Repo s can be assets besides tbills such as mortgage backed securities or commercial paper Mismatched maturities of loans The tendency of a business to mismatch its balance sheet by possessing more short term liabilities than short term assets and having more assets than liabilities for medium and long term obligations Due diligence The research done on potential investments How investment banking has changed from the past Partnerships to publicly traded Changes in risk taking Became much more leveraged and used a lot more repo financing Principal agent problem the concern that the agent may make decisions on the behalf of the principal that are not ideal Leverage Borrowing money to invest with After 1999 there was a ton of this Executive compensation People say they are paid too much currently Dodd frank act reduces compensation Proprietary trading Used to never do this but nowadays they do Using the firms own capital to make investments Financial engineering innovation MBS mortgage backed securities Securities backed by the mortgages on people s houses CDOs collateralized debt obligations conglomerate of MBS s Repos liquidity problems Globalization Shadow Banking and the 2007 09 Credit Crisis Size in relation to commercial banking When the financial crisis happened the shadow banking industry hedge funds mutuals investment banking was bigger than the commercial banking industry Repeal of Glass Steagall and emergence of financial holding companies 2 Holding companies can be subjected to more strict regulation but also get access to federal reserve loans to get through the recession Systemic risk The risk to the entire financial industry No FDIC insurance in the shadow banking industry makes this risk very critical Shadow Banking System Everything besides commercial banking Idea of problems with Dodd Frank Congressional bill intended to mitigate problems in the shadow banking system the potential problem is that it could be too hard to monitor all firms and what they do Chapter 8 Outline Securities Tx Capital vs money market All stocks are in the capital markets Long term 1 year Short term 1 year debt equity securities are traded in money markets Primary vs secondary market o New debt equity securities are issued and sold in the primary market The proceeds from selling these securities goes tot he issuing entity Firm to investor o The secondary market is where securities are re traded This is where almost all trading occurs Investor to investor Primary market The only purpose of this market is to sell brand new securities so that firms can raise money IPOs initial public offering First public sale of a firm s stock Seasoned stock offering 3 o New stock issue of an already publicly traded firm Private equity offerings IPOs Why use an underwriter Typically an investment bank o Non public offering of a company s equity Terminology Lead underwriter This is the lead investment bank involved in the IPO They coordinate and manage the whole process They typically purchase all the shares of the stock from the firm so that the firm faces no risk of not selling their shares and not raising the money they need Additional investment banks brought in by the lead underwriter to share the Syndicate financial risk if needed Selling group The total group of investment banks and brokerage firms brought in by the syndicate and responsible for selling the stock issue How process works Underwriting Process Find an underwriter Investment bank Underwriter buys shares Prospectus S 1 Registration Describes the issue and the issuer This tells what the company does what it plans on doing what financial challenges it currently faces and may face provides information about owners and management of the company etc Preliminary prospectus prior to SEC approval The process of going around to institutional investors trying to sell the IPO shares The reputation of the underwriter is very important here as they are backing the investment as a good one Potential investors will say how many shares they may be willing to purchase at what price This is the period when the firm must limit the disclosure of new information obtained about the firm after the SEC has approved the prospectus Red Herring Roadshow Quiet period Pricing and profit IPO offer price This is the price that institutional investors pay for the stock IPO price in the public market The first price that people like you and me can purchase IPO stock at is the price that institutional investors are willing to let it go for This can be significantly higher than the price they paid It all depends on the demand of the stock Spread 4 The difference in price between what the underwriter pays and what the shares are priced at when it is in the
View Full Document
Unlocking...