3-1 chapter 3 financial intermediaries. 3-2 deficit sectors financial intermediaries claims surplus...
TRANSCRIPT
3-1
Chapter 3
Financial Intermediaries
3-2
Deficit Sectors
Financial Intermediaries
Claims
Surplus Sectors
$
Claims Claims
$ $
3-3
Pooling of small savings.Diversification of risks.Economies of scale in monitoring
information and evaluating risks.Lower transactions costs.Special reasons.The above are not mutually exclusive.
Advantages of Financial Intermediaries
3-4
The primary market for securities involves the initial sale.
The secondary market for securities involves the resale.
Primary Market vs. Secondary Market
3-5
Investment banking is the marketing of securities when they are initially sold.
Some securities are sold to private buyers. Others are sold to the public. The exact difference is a technical legal issue.
Public offerings must be registered with the Securities and Exchange Commission (SEC).
Investment Banking
3-6
Investment banking firms sell public offerings. They are essentially marketers of securities and charge a fee for their services. This is often called an underwriting fee.
Syndicates of investment banks are often involved in public offerings. This spreads the resale risk.
Public Offerings
3-7
Firm Commitments. The investment banker purchases the security issue outright and bears the resale risk.
Best Efforts. The investment bankers sell whatever they’re able.
Fees for firm commitments are much higher. Most bond issues are sold by firm commitment.
Types of Public Offerings
3-8
Shelf Registration.Some securities are sold by shelf
registration. This is essentially a pre- registration of a security issue. Anytime during the next two years the securities can be brought to market very rapidly.
Rule 144A. They do not have to be registered with
the SEC and can be resold to other qualified financial institutions.
3-9
UnderwriterSpread
BondRating
4%
2%
.75%
AAA AA A BBB BB B
3%
3-10
Many securities are traded on organized exchanges such as the New York Stock Exchange or NASDAQ.
Most bonds are traded over-the-counter (OTC). The OTC market is a network of dealers located throughout the country.
Some securities are traded over anonymous electronic trading systems.
Secondary Market
3-11
Dealers are marketmakers for securities. They maintain an inventory and buy and sell from that inventory. A dealer offers to buy at the bid price and offers to sell at the asked price.
The size of the bid-asked spread depends upon two major factors. Volume of trading. Inherent price risk.
Security Dealers
3-12
Brokers are agents who carry out transactions for buyers or sellers. Brokers charge commissions for their services.
There are different types of brokers.Full-service brokers provided execution
and advice and charge the highest fees.Discount brokers provided execution
only.
Security Brokers
3-13
Mutual funds represent a pooling of funds by many investors.
Open-end vs. closed-end funds.Net Asset Value (NAV) = liquidating
value.For closed end funds, typically
Price < NAV.
Mutual Funds
3-14
Information Economies.Diversification.Lower transactions costs.
Advantages of Mutual Funds
3-15
Mutual Fund Costs
Sales FeesFront End LoadRear End Load12b-1 Fees (Annual)
3-16
Mutual Fund Costs
Expense ratio includes:Management fee.Administrative fee.Other fees.
Additional Costs:Brokerage commissions.
3-17
Life insurance.Casualty insurance. Insurance companies are large
investors in fixed income securities.Adverse selection.Moral hazard. Coinsurance.
Insurance Companies
3-18
Defined benefit plans. Dollars paid out usually set by some formula, e.g., Pension = (# Years)(Average) (X%). Pension Benefit Guarantee Corporation. Employer bears the reinvestment risk.
Defined contribution plans. Dollars paid in are specified. Dollars paid out depend upon returns. Employee bears the reinvestment risk.
Pension Funds
3-19
Reinvestment
0 1 2Horizon
Date
Time$ In C C $ Out
Pension Funds Cash Flows
3-20
Pension Benefit Guaranty Corporation
Insures pensions of private defined benefit plans.
Does not ensure government defined benefit plans.
Collects premiums from covered plans.
Underfunded.Limited benefits.
3-21
Heavily regulated. Safety. Widespread effects. Competition.
Regulatory agencies. The Federal Reserve. The FDIC. The comptroller of the currency. State banking authorities.
Charters. Branches. Insurance. Capital. Failure.
Commercial Banks and Thrifts
3-22
Important Regulations
Glass Steagall Act – separated commercial banking from investment banking, dealers, brokers, mutual funds, insurance.
Restrictions lifted beginning in 1980s and repealed in 1999.
3-23
Important Regulations
RESTRICTIONS ON BRANCHING Banks used to be restricted to
operating in one state.Within states, there were three types
of branching rules: one office, limited branching, unrestricted branching.
3-24
Bank Economies of ScaleCost per Dollar of Assets
Size
High Cost
LowCost
SmallBank
LargeBank
3-25
Federal Deposit Insurance Corporation
FDIC has the power to close failing banks.
FDIC insurance covers depositors up to $250,000 for any shortfalls.
3-26
Bank Balance Sheet
AssetsLiabilities &
Equity
BookValue
MarketValue
BookValue
MarketValue
Cash 20 20 Deposits 150 150
Loans 170 100 Bonds 40 0
Building 10 10 Equity 10 0
200 130 200 150