Lecture-1-Introduction_Course-Overview_Ch1-Why-Study-Financial-Institutions1.ppt

WelcomeandCourseOverview ACF104FinancialInstitutions 1 1 IntroductionofVisitingLecturerCourseOverviewAssessmentLogistics Lecture1onChapter1 WhyStudyFinancialMarketsandInstitutions 2 ACF104FinancialInstitutions ChapterPreview ACF104FinancialInstitutions 1 3 Wepreviewsubjectsofinteresttoanyonewhoisapartofaproductivesociety Wemotivatehowfinancialmarketsandinstitutionshavesignificantimpactonimportantquestionsaboutourfinancialwell being Topicsinclude WhyStudyFinancialMarkets WhyStudyFinancialInstitutions WhyStudyFinancialMarkets ACF104FinancialInstitutions 1 4 Channelsfundsfromsaverstoinvestors therebypromotingeconomicefficiency Affectspersonalwealthandbehaviorofbusinessfirms WhyStudyFinancialMarkets ACF104FinancialInstitutions 1 5 Wellfunctioningfinancialmarkets suchasthebondmarket stockmarket andforeignexchangemarket arekeyfactorsinproducinghigheconomicgrowth Wewillbrieflyexamineeachofthesemarkets keystatistics andhowwewillexaminethemthroughoutthiscourse WhyStudyFinancialMarkets DebtMarkets InterestRates ACF104FinancialInstitutions 1 6 Debtmarkets orbondmarkets allowgovernments corporations andindividualstoborrowtofinanceactivities Therelationshipbetweenthesemarketsandinterestrateswillbeestablishedinseveralchaptersthroughoutthiscourse WhyStudyFinancialMarkets TheForeignExchangeMarket ACF104FinancialInstitutions 1 7 Theforeignexchangemarketiswhereinternationalcurrenciestradeandexchangeratesareset Althoughmostpeopleknowlittleaboutthismarket ithasadailyvolumearound 1trillion Viewhistoricalfinancialdataandforecastsathttp www forecasts org data index htm WhyStudyFinancialInstitutions ACF104FinancialInstitutions 1 8 Wewillalsospendconsiderabletimediscussingfinancialinstitutions thecorporations organizations andnetworksthatoperatetheso called marketplaces Wewilllookat CentralBanksandtheConductofMonetaryPolicyTheroleoftheFedandforeigncounterpartsStructureoftheFinancialSystemHelpsgetfundsfromsaverstoinvestors WhyStudyFinancialInstitutions ACF104FinancialInstitutions 1 9 BanksandOtherFinancialInstitutionsIncludestheroleofinsurancecompanies mutualfunds pensionfunds etc FinancialInnovationFocusingontheimprovementsintechnologyanditsimpactonhowfinancialproductsaredeliveredManagingRiskinFinancialInstitutionsFocusingonriskmanagementinthefinancialinstitution AppliedManagerialPerspective ACF104FinancialInstitutions 1 10 FinancialinstitutionsareamongthelargestemployersintheU S andmanyothercountriesandoftenpayhighsalaries Knowinghowfinancialinstitutionsaremanagedmayhelpyoubetterdealwiththem ChapterSummary ACF104FinancialInstitutions 1 11 WhyStudyFinancialMarkets thethreeprimarymarkets bond stock andforeignexchange werebrieflyintroduced WhyStudyFinancialInstitutions themarket institutions andkeychangesaffectingthesewereoutlined Chapter2 OverviewoftheFinancialSystem 12 ACF104FinancialInstitutions ChapterPreview ACF104FinancialInstitutions 2 13 Weexaminetheroleofthefinancialsysteminanadvancedeconomy Westudytheeffectsoffinancialmarketsandinstitutionsontheeconomy andlookattheirgeneralstructureandoperations Topicsinclude FunctionofFinancialMarketsStructureofFinancialMarketsInternationalizationofFinancialMarketsFunctionofFinancialIntermediariesFinancialIntermediariesRegulationoftheFinancialSystem FunctionofFinancialMarkets ACF104FinancialInstitutions 2 14 Allowstransfersoffundsfrompersonorbusinesswithoutinvestmentopportunities i e Lender Savers toonewhohasthem i e Borrower Spenders Improveseconomicefficiency FinancialMarketsFundsTransferees ACF104FinancialInstitutions 2 15 Lender SaversHouseholdsBusinessfirmsGovernmentForeigners Borrower SpendersBusinessfirmsGovernmentHouseholdsForeigners SegmentsofFinancialMarkets ACF104FinancialInstitutions 2 16 DirectFinanceBorrowersborrowdirectlyfromlendersinfinancialmarketsbysellingfinancialinstrumentswhichareclaimsontheborrower sfutureincomeorassetsIndirectFinanceBorrowersborrowindirectlyfromlendersviafinancialintermediaries establishedtosourcebothloanablefundsandloanopportunities byissuingfinancialinstrumentswhichareclaimsontheborrower sfutureincomeorassets FunctionofFinancialMarkets ACF104FinancialInstitutions 2 17 Figure2 1FlowofFundsThroughtheFinancialSystem ImportanceofFinancialMarkets ACF104FinancialInstitutions 2 18 Financialmarketsarecriticalforproducinganefficientallocationofcapital whichcontributestohigherproductionandefficiencyfortheoveralleconomy aswellaseconomicsecurityforthecitizenryasawholeFinancialmarketsalsoimprovethelotofindividualparticipantsbyprovidinginvestmentreturnstolender saversandprofitand oruseopportunitiestoborrower spenders ClassificationsofFinancialMarkets ACF104FinancialInstitutions 2 19 DebtMarketsShort Term maturity1year CapitalMarketEquityMarketsCommonStock CharacteristicsofDebtMarketsInstruments ACF104FinancialInstitutions 2 20 DebtinstrumentsBuyersofdebtinstrumentsaresuppliers ofcapital tothefirm notownersofthefirmDebtinstrumentshaveafinitelifeormaturitydateAdvantageisthatthedebtinstrumentisacontractualpromisetopaywithlegalrightstoenforcerepaymentDisadvantageisthatreturn profitisfixedorlimited CharacteristicsofEquityMarketsInstruments ACF104FinancialInstitutions 2 21 Equityinstruments commonstockismostprevalentequityinstrument BuyersofcommonstockareownersofthefirmCommonstockhasnofinitelifeormaturitydateAdvantageofcommonstockispotentialhighincomesincereturnisnotfixedorlimitedDisadvantageisthatdebtpaymentsmustbemadebeforeequitypaymentscanbemade CharacteristicsofFinancialMarkets ACF104FinancialInstitutions 2 22 DebtMarketsAlthoughlesswell knownbytheaverageperson debtmarketsinU S aremuchlargerintotaldollarsthanequitymarkets duetogreaternumberofparticipantclasses households businesses government andforeigners andsizeofindividualparticipants businesses andgovernment CharacteristicsofFinancialMarkets ACF104FinancialInstitutions 2 23 EquityMarketsAlthoughU S marketsarehighlyefficient theworld slargest andmorefamiliartotheaverageperson theyarefarsmallerthantheU S debtmarketslargelyduetothefactthattheonlyapplicableparticipantsarebusinesses ClassificationsofFinancialMarkets ACF104FinancialInstitutions 2 24 PrimaryMarketNewsecurityissuessoldtoinitialbuyersSecondaryMarketSecuritiespreviouslyissuedareboughtandsold ClassificationsofFinancialMarkets ACF104FinancialInstitutions 2 25 ExchangesTradesconductedincentrallocations e g NewYorkStockExchange Over the CounterMarketsDealersatdifferentlocationsbuyandsell NYSEhomepage InternationalizationofFinancialMarkets ACF104FinancialInstitutions 2 26 InternationalBondMarketForeignbondsEurobonds nowlargerthanU S corporatebondmarket WorldStockMarketsU S stockmarketsarenolongeralwaysthelargest atonepoint Japan swaslarger FunctionofFinancialIntermediaries FIs ACF104FinancialInstitutions 2 27 FinancialIntermediariesEngageinprocessofindirectfinanceMoreimportantsourceoffinancethansecuritiesmarketsNeededbecauseoftransactionscostsandasymmetricinformation FunctionofFinancialIntermediaries ACF104FinancialInstitutions 2 28 TransactionsCostsFinancialintermediariesmakeprofitsbyreducingtransactionscostsReducetransactionscostsbydevelopingexpertiseandtakingadvantageofeconomiesofscale FunctionofFinancialIntermediaries ACF104FinancialInstitutions 2 29 Afinancialintermediary slowtransactioncostsmeanthatitcanprovideitscustomerswithliquidityservices servicesthatmakeiteasierforcustomerstoconducttransactionsBanksprovidedepositorswithcheckingaccountsthatenablethemtopaytheirbillseasilyDepositorscanearninterestoncheckingandsavingsaccountsandyetstillconvertthemintogoodsandserviceswhenevernecessary FunctionofFinancialIntermediaries ACF104FinancialInstitutions 2 30 AnotherbenefitmadepossiblebytheFI slowtransactioncostsisthattheycanhelpreducetheexposureofinvestorstorisk throughaprocessknownasrisksharingFIscreateandsellassetswithlesserrisktoonepartyinordertobuyassetswithgreaterriskfromanotherpartyThisprocessisreferredtoasassettransformation becauseinasenseriskyassetsareturnedintosaferassetsforinvestors AsymmetricInformation AdverseSelectionandMoralHazard ACF104FinancialInstitutions 2 31 AdverseSelectionBeforetransactionoccursPotentialborrowersmostlikelytoproduceadverseoutcomeareonesmostlikelytoseekloanandbeselected AsymmetricInformation AdverseSelectionandMoralHazard ACF104FinancialInstitutions 2 32 MoralHazardAftertransactionoccursHazardthatborrowerhasincentivestoengageinundesirable immoral activitiesmakingitmorelikelythatwon tpayloanback AsymmetricInformation AdverseSelectionandMoralHazard ACF104FinancialInstitutions 2 33 Financialintermediariesreduceadverseselectionandmoralhazardproblems enablingthemtomakeprofits Howtheydothisisthecoveredinmanyofthechapterstocome FinancialIntermediaries ACF104FinancialInstitutions 2 34 SizeofFinancialIntermediaries ACF104FinancialInstitutions 2 35 TypesofFinancialIntermediaries ACF104FinancialInstitutions 2 36 DepositoryInstitutions Banks CommercialbanksSavings LoanAssociations S Ls MutualSavingsBanksContractualSavingsInstitutionsLifeinsurancecompaniesFire casualtyinsurancecompaniesPensionfunds governmentretirementfunds TypesofFinancialIntermediaries ACF104FinancialInstitutions 2 37 InvestmentIntermediariesFinancecompaniesMutualfundsMoneymarketmutualfunds DepositoryInstitutions Banks ACF104FinancialInstitutions 2 38 CommercialbanksRaisefundsprimarilybyissuingcheckable savings andtimedepositswhichareusedtomakecommercial consumerandmortgageloansCollectively thesebankscomprisethelargestfinancialintermediaryandhavethemostdiversifiedassetportfolios DepositoryInstitutions Banks ACF104FinancialInstitutions 2 39 S Ls MutualSavingsBanksandCreditUnionsRaisefundsprimarilybyissuingsavings time andcheckabledepositswhicharemostoftenusedtomakemortgageandconsumerloans withcommercialloansalsobecomingmoreprevalentatS LsandMutualSavingsBanksMutualsavingsbanksandcreditunionsissuedepositsassharesandareownedcollectivelybytheirdepositors mostofwhichatcreditunionsbelongtoaparticulargroup e g acompany sworkers ContractualSavingsInstitutions CSIs ACF104FinancialInstitutions 2 40 AllCSIsacquirefundsfromclientsatperiodicintervalsonacontractualbasisandhavefairlypredictablefuturepayoutrequirements LifeInsuranceCompaniesreceivefundsfrompolicypremiums caninvestinlessliquidcorporatesecuritiesandmortgages sinceactualbenefitpayoutsareclosetothosepredictedbyactuarialanalysisFireandCasualtyInsuranceCompaniesreceivefundsfrompolicypremiums mustinvestmostinliquidgovernmentandcorporatesecurities sincelosseventsarehardertopredict ContractualSavingsInstitutions CSIs ACF104FinancialInstitutions 2 41 AllCSIsacquirefundsfromclientsatperiodicintervalsonacontractualbasisandhavefairlypredictablefuturepayoutrequirements PensionandGovernmentRetirementFundshostedbycorporationsandstateandlocalgovernmentsacquirefundsthroughemployeeandemployerpayrollcontributions investincorporatesecurities andprovideretirementincomeviaannuities InvestmentIntermediaries ACF104FinancialInstitutions 2 42 FinanceCompaniessellcommercialpaper ashort termdebtinstrument andissuebondsandstockstoraisefundstolendtoconsumerstobuydurablegoods andtosmallbusinessesforoperationsMutualFundsacquirefundsbysellingsharestoindividualinvestors manyofwhosesharesareheldinretirementaccounts andusetheproceedstopurchaselarge diversifiedportfoliosofstocksandbonds InvestmentIntermediaries ACF104FinancialInstitutions 2 43 MoneyMarketMutualFundsacquirefundsbysellingcheckabledeposit likesharestoindividualinvestorsandusetheproceedstopurchasehighlyliquidandsafeshort termmoneymarketinstruments RegulatoryAgencies ACF104FinancialInstitutions 2 44 RegulationofFinancialMarkets ACF104FinancialInstitutions 2 45 ThreeMainReasonsforRegulationIncreaseInformationtoInvestorsEnsuretheSoundnessofFinancialIntermediariesImproveMonetaryControl RegulationReason IncreaseInvestorInformation ACF104FinancialInstitutions 2 46 AsymmetricinformationinfinancialmarketsmeansthatinvestorsmaybesubjecttoadverseselectionandmoralhazardproblemsthatmayhindertheefficientoperationoffinancialmarketsandmayalsokeepinvestorsawayfromfinancialmarketsTheSecuritiesandExchangeCommission SEC requirescorporationsissuingsecuritiestodisclosecertaininformationabouttheirsales assets andearningstothepublicandrestrictstradingbythelargeststockholders knownasinsiders inthecorporation RegulationReason IncreaseInvestorInformation ACF104FinancialInstitutions 2 47 Suchgovernmentregulationcanreduceadverseselectionandmoralhazardproblemsinfinancialmarketsandincreasetheirefficiencybyincreasingtheamountofinformationavailabletoinvestors RegulationReason EnsureSoundnessofFinancialIntermediaries ACF104FinancialInstitutions 2 48 Becauseprovidersoffundstofinancialintermediariesmaynotbeabletoassesswhethertheinstitutionsholdingtheirfundsaresoundornot iftheyhavedoubtsabouttheoverallhealthoffinancialintermediaries theymaywanttopulltheirfundsoutofbothsoundandunsoundinstitutions withthepossibleoutcomeofafinancialpanicthatproduceslargelossesforthepublicandcausesseriousdamagetotheeconomy RegulationReason EnsureSoundnessofFinancialIntermediaries cont ACF104FinancialInstitutions 2 49 Toprotectthepublicandtheeconomyfromfinancialpanics thegovernmenthasimplementedsixtypesofregulations RestrictionsonEntryDisclosureRestrictionsonAssetsandActivitiesDepositInsuranceLimitsonCompetitionRestrictionsonInterestRates Regulation RestrictiononEntry ACF104FinancialInstitutions 2 50 RestrictionsonEntryRegulatorshavecreatedverytightregulationsastowhoisallowedtosetupafinancialintermediaryIndividualsorgroupsthatwanttoestablishafinancialintermediary suchasabankoraninsurancecompany mustobtainacharterfromthestateorthefederalgovernmentOnlyiftheyareupstandingcitizenswithimpeccablecredentialsandalargeamountofinitialfundswilltheybegivenacharter Regulation Disclosure ACF104FinancialInstitutions 2 51 DisclosureRequirementsTherearestringentreportingrequirementsforfinancialintermediariesTheirbookkeepingmustfollowcertainstrictprinciples Theirbooksaresubjecttoperiodicinspection Theymustmakecertaininformationavailabletothepublic Regulation RestrictiononAssetsandActivities ACF104FinancialInstitutions 2 52 TherearerestrictionsonwhatfinancialintermediariesareallowedtodoandwhatassetstheycanholdBeforeyouputyourfundsintoabankorsomeothersuchinstitution youwouldwanttoknowthatyourfundsaresafeandthatthebankorotherfinancialintermediarywillbeabletomeetitsobligationstoyou Regulation RestrictiononAssetsandActivities ACF104FinancialInstitutions 2 53 OnewayofdoingthisistorestrictthefinancialintermediaryfromengagingincertainriskyactivitiesAnotherwayistorestrictfinancialintermediariesfromholdingcertainriskyassets oratleastfromholdingagreaterquantityoftheseriskyassetsthanisprudent Regulation DepositInsurance ACF104FinancialInstitutions 2 54 ThegovernmentcaninsurepeopleprovidingfundstoafinancialintermediaryfromanyfinanciallossifthefinancialintermediaryshouldfailTheFederalDepositInsuranceCorporation FDIC insureseachdepositoratacommercialbankormutualsavingsbankuptoalossof 250 000peraccount textsays 100 000 Regulation DepositInsurance ACF104FinancialInstitutions 2 55 Similargovernmentagenciesexistforotherdepositoryinstitutions TheSavingsAssociationInsuranceFund partoftheFDIC providesdepositinsuranceforsavingsandloanassociations andtheNationalCreditUnionShareInsuranceFund NCUSIF doesthesameforcreditunions Regulation PastLimitsonCompetition ACF104FinancialInstitutions 2 56 Althoughtheevidencethatunbridledcompetitionamongfinancialintermediariespromotesfailuresthatwillharmthepublicisextremelyweak ithasnotstoppedthestateandfederalgovernmentsfromimposingmanyrestrictiveregulationsInthepast bankswerenotallowedtoopenupbranchesinotherstates andinsomestatesbankswererestrictedfromopeningadditionallocations Regulation PastRestrictionsonInterestRates ACF104FinancialInstitutions 2 57 CompetitionhasalsobeeninhibitedbyregulationsthatimposerestrictionsoninterestratesthatcanbepaidondepositsTheseregulationswereinstitutedbecauseofthewidespreadbeliefthatunrestrictedinterest ratecompetitionhelpedencouragebankfailuresintheUSduringtheGreatDepressionLaterevidencedoesnotseemtosupportthisview andrestrictionsoninterestrateshavebeenabolished RegulationReason ImproveMo