OSU BA 441 - Chapter 2 - Financial Intermediaries

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Financial Markets and Institutions – BA 441Chapter 2 – Financial IntermediationSlide 3Slide 4Slide 5Slide 6Slide 7Slide 8Slide 9Slide 10Financial Markets and Institutions – BA 441Monday -- Wednesday Bexell 32010:00 a.m. to 11:50 a.m.Chapter 2 – Financial IntermediationDefinition of Financial IntermediationTransforming financial assets into more widely preferred type of asset/liabilityExample: Car LoanExample: Swap (Bond swap from fixed to floating rate)Performed by Financial InstitutionsMany of these intermediation functions are completed with large institutionsCompleted in Financial MarketsChapter 2 – Financial IntermediationA closer look at Financial InstitutionsTypesBanks – Commercial, Investment, Savings and Loans, Credit Unions, etc.Investment CompaniesInsurance CompaniesOthers – Pension Funds, Foundations, etc.FunctionsTransforming, Exchanging, and Designing Financial AssetsAdvising and Managing Financial AssetsChapter 2 – Financial IntermediationDirect Investing with IntermediariesCommercial BankDirect Deposit – CD – Promised Payment at the end of the Investment PeriodDollars are loaned to a borrower (to buy a car) with a different payment scheduleIndirect Investing with IntermediariesMutual Fund Company (Investment Company)Buy mutual fund shares at NAV (no load)Company uses funds to buy stocks and bondsChapter 2 – Financial IntermediationFour Functions of IntermediationMaturityBorrow in the long vs. lend in the shortRisk Reduction (Diversification)Eliminate firm specific risk via a portfolioCost Reduction of Information/ContractingShare information acquired across large set of individualsPayment MechanismsChecks, Credit Cards, Debit Cards, etc.Chapter 2 – Financial IntermediationAsset/Liability Management for Financial InstitutionsNature of Business – Buy and Sell MoneyBuy Low, Sell High – SpreadNature of LiabilitiesTiming and Amount of Outflow of CashTable 2-1 Page 19Liquidity of Claims against Financial Institutions – can obligations be met with current assets of the institution?Chapter 2 – Financial IntermediationGrowth of Financial Intermediaries through Financial InnovationMarket Broadening Instruments – attracts new investorsZero-Coupon Bonds – TGIRS, LYONS, etcRisk Management Instruments Options Arbitrage Instruments – Price StabilityIndex Assets for direct tradeMotivation? Risk Transfer or ArbitrageChapter 2 – Financial IntermediationAsset SecuritizationPledging Cash Flows from a set of borrowers to the lenders of the funds…Example Mortgage Backed SecuritiesGinnie Mae, Sallie Mae, Freddie Mac…Conforming Loans are the security for the Bonds sold to investors and the payment of the mortgage payment flows to bondholdersOriginal Lender to Mortgage does not service loans – just pools loans and sells bondsCosts and Benefits? Implications?Chapter 2 – Financial IntermediationEnd of Chapter Questions#7 – Mutual Funds – Advantages and Disadvantages for InvestorAdvantagesRisk Reduction – Portfolio Cost Reduction for information and transactionsRecord KeepingDisadvantagesLoss of flexibility for individual investorPay gains annually stock appreciationConclusion – Meets the needs of many investors thus the growth…Chapter 2 – Financial IntermediationEnd of Chapter Questions#8 – Volatility Increases InnovationGreater Volatility means Greater RiskGreater Risk means Benefits of Risk Transfer IncreasesFinancial Innovation is finding an efficient way to transfer risk so greater volatility increases the benefits of new ways to transfer risk.#10 – Asset Securitization and LiquidityLiquidity of Market (instruments have a secondary market)New Lenders that find “niche” meets their


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OSU BA 441 - Chapter 2 - Financial Intermediaries

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