Financial Markets and Institutions – BA 543

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					Financial Markets and
Institutions – BA 441

   Monday -- Wednesday
         Bexell 103
   8:00 a.m. to 9:50 a.m.
Chapter 2 – Financial Intermediation
n Definition of Financial Intermediation
   n   Transforming financial assets into more widely
       preferred type of asset/liability
        n   Example: Car Loan
        n   Example: Swap (Bond swap from fixed to floating
n Performed by Financial Institutions
   n   Many of these intermediation functions are
       completed with large institutions
n Completed in Financial Markets
Chapter 2 – Financial Intermediation
n A closer look at Financial Institutions
  n Types
        n   Banks – Commercial, Investment, Savings and
            Loans, Credit Unions, etc.
        n   Investment Companies
        n   Insurance Companies
        n   Others – Pension Funds, Foundations, etc.
   n   Functions
        n   Transforming, Exchanging, and Designing
            Financial Assets
        n   Advising and Managing Financial Assets
Chapter 2 – Financial Intermediation
n Direct Investing with Intermediaries
  n   Commercial Bank
       n   Direct Deposit – CD – Promised Payment at the
           end of the Investment Period
       n   Dollars are loaned to a borrower (to buy a car)
           with a different payment schedule
n Indirect Investing with Intermediaries
  n   Mutual Fund Company (Investment Company)
       n   Buy mutual fund shares at NAV (no load)
       n   Company uses funds to buy stocks and bonds
Chapter 2 – Financial Intermediation
n Four Functions of Intermediation
  n   Maturity
       n   Borrow in the long vs. lend in the short
  n   Risk Reduction (Diversification)
       n   Eliminate firm specific risk via a portfolio
  n   Cost Reduction of Information/Contracting
       n   Share information acquired across large set of
  n   Payment Mechanisms
       n   Checks, Credit Cards, Debit Cards, etc.
Chapter 2 – Financial Intermediation
n Asset/Liability Management for Financial
  n Nature of Business – Buy and Sell Money
  n Buy Low, Sell High – Spread
n Nature of Liabilities
   n Timing and Amount of Outflow of Cash
   n Table 2-1 Page 19
n Liquidity of Claims against Financial
  Institutions – can obligations be met with
  current assets of the institution?
Chapter 2 – Financial Intermediation
n Growth of Financial Intermediaries through
  Financial Innovation
  n   Market Broadening Instruments – attracts new
       n   Zero-Coupon Bonds – TGIRS, LYONS, etc
  n   Risk Management Instruments
       n   Options
  n   Arbitrage Instruments – Price Stability
       n   Index Assets for direct trade
  n   Motivation? Risk Transfer or Arbitrage
Chapter 2 – Financial Intermediation
n Asset Securitization
  n Pledging Cash Flows from a set of borrowers
    to the lenders of the funds…
  n Example Mortgage Backed Securities
       n   Ginnie Mae, Sallie Mae, Freddie Mac…
       n   Conforming Loans are the security for the Bonds
           sold to investors and the payment of the
           mortgage payment flows to bondholders
       n   Original Lender to Mortgage does not service
           loans – just pools loans and sells bonds
  n   Costs and Benefits? Implications?
Chapter 2 – Financial Intermediation
n End of Chapter Questions
  n #7 – Mutual Funds – Advantages and
    Disadvantages for Investor
       n   Advantages
            § Risk Reduction – Portfolio
            § Cost Reduction for information and transactions
            § Record Keeping
       n   Disadvantages
            § Loss of flexibility for individual investor
            § Pay gains annually stock appreciation
  n   Conclusion – Meets the needs of many
      investors thus the growth…
Chapter 2 – Financial Intermediation
n End of Chapter Questions
  n #8 – Volatility Increases Innovation
        n   Greater Volatility means Greater Risk
        n   Greater Risk means Benefits of Risk Transfer
        n   Financial Innovation is finding an efficient way to
            transfer risk so greater volatility increases the
            benefits of new ways to transfer risk.
   n   #10 – Asset Securitization and Liquidity
        n   Liquidity of Market (instruments have a secondary
        n   New Lenders that find “niche” meets their

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