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Chapter 13

Chapter 13. Non depository Financial Institutions. Life Insurance Companies. Structure Stock companies Owned and controlled by shareholders Mutual associations Ownership and control rests with the policyholders Supervision and regulation States in which they operate.

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Chapter 13

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  1. Chapter 13 Non depository Financial Institutions

  2. Life Insurance Companies • Structure • Stock companies Owned and controlled by shareholders • Mutual associations Ownership and control rests with the policyholders • Supervision and regulation • States in which they operate

  3. Life Insurance Companies • Regulation of life insurance companies includes: • Sales practices • Premium rates • Allowable investments • Usually overseen by • State insurance commissioner • State banking commissioner

  4. Life Insurance Companies • Whole Life Insurance • Constant premium that is paid through entire life of policy • Includes a Savings component • Build up cash reserves or savings • Pays a money market rate of interest • Can be borrowed • Withdrawn by canceling the policy

  5. Life Insurance Companies Term Life Insurance • Pure insurance with no cash reserve or savings element • Premiums are relatively low at first but increase with the age of the insured individual

  6. Life Insurance Companies Universal Life Insurance • Whole life paid little interest on the savings component • Consumers bought term life for insurance and MMMF for savings • Universal life offered just that • Owner can elect how to allocate the savings component among a menu of investment options

  7. Life Insurance Companies • Based on actuarial tables, life insurance companies have ability to predict cash flow • Typically insurance companies use excess funds to invest in: • Long-term corporate bonds and commercial mortgages • Offers higher yields • Unlikely of having to sell prior to maturity • Recently, they have started to invest in riskier ventures: • Common stock • Real estate

  8. Pension Funds • Supplement Social Security Benefits after retirement. • Most pension fund assets are in employer-sponsored plans • Defined Benefit Plan • Benefits are defined by the plan at the begining. • Employer contributions are adjusted to meet the benefits

  9. Pension Funds • Defined Benefit Plan • Fully Funded • When employer puts in enough funds to meet future obligations • Due to compounded interest rate • Vested • When benefits stays with the employee even if they leave the firm. It is based on length of employment

  10. Defined Benefit Plan • Employee Retirement Income Security Act (ERISA) A federal act that designed safeguard employee pension rights. It imposes: • Reporting and Disclosure requirements • Reporting vesting and funding information • Investment standards • Pension Benefit Guaranty Corporation (PBGC) A federal plan that guarantees some benefits in defined benefit plans if company is unable to meet its pension liabilities

  11. Defined Contribution Plans • Defined Contribution Plan • Benefits are not pre-defined rather depend upon the performance of the assets in the plan • Contribution may be made by employees or employers or a combination of the two • Employee contributions are tax deferred • Individual employee has the ability to choose the assets in which to invest • Aggressive when young • Conservative when it is time to retire • Avoids the problems of vesting and funding

  12. Pension Funds Some of the common Pension Plans are • 401(k): • Employee in for profit corporation • 403(b): • Employee in not for profit corporation • Keogh Plans • Self-employed individuals • Individual Retirement Accounts (IRAs) • Working people who are not covered by company-sponsored pension plans

  13. Insurance Companies • Property and Casualty Insurance Can not plan for their future cash requirements as predictably as life insurance companies • Tend to invest in: • liquid short-term securities • Highly liquid but lower yields • tax-free municipal bonds • Regulation and supervision • States in which they operate

  14. Insurance Companies • State insurance commissions • Set ranges for rates • Enforce operating standards • Exercise overall supervision over company policies • Little or no federal regulation

  15. Mutual Funds Definition • A mutual fund pools the funds of many small saver • Fund managers invest the money in a diversified portfolio of securities • Provides limited check writing ability

  16. Mutual Funds Open-end Mutual Fund • Sells shares to the general public • Shares represent a proportionate ownership in a portfolio held by the fund • Shareholders can directly buy additional shares • Shareholders redeem shares at the Net Asset Value (NAV)

  17. Mutual Funds Net Asset Value (NAV) • No Load Funds: Sold directly to public at the current NAV • Load Funds: • Sold through brokers • Buyer pays a sales commission

  18. Mutual Funds Closed-end Mutual Funds • Issue a limited number of shares • Mutual fund company does not redeem their own shares on demand • Shares of closed-end funds are traded in the stock market through a third party

  19. Mutual Funds • Regulation • Securities and Exchange Commission (SEC) • Primary objective of regulation • Enforcement of reporting and • Ensure adequate disclosure • Protect the investor • Families of mutual funds • Number of mutual funds operated under one management umbrella • Investors can easily transfer money across funds within the family

  20. Finance Companies Consumer Finance Companies • Make consumer loans • Specialty Finance Company specializes in credit card financing Commercial Finance Companies • Make commercial loans usually on a secured (collateralized) basis • Loans not less riskier consumer loans, but more riskier than loans made by commercial banks • Lending is short-term • Borrows substantial amounts in commercial paper market

  21. Finance Companies • Historically finance companies have played an important role in financing undercapitalized companies • Commercial finance companies originated the concept of Leveraged Buy Out (LBOs) which relies heavily on debt to pay for acquisition of a company • Captive Finance Companies Finance purchase of commercial and retail oriented businesses such as General Motors products (GMAC)

  22. Securities Brokers and Dealers and Investment Banks • These financial institutions play a crucial role in the distribution and trading of huge amounts of securities • Investment banks • Sell and distribute new stocks and bonds directly from issuing corporations to original purchasers • League Tables rank investment banks by the volume of securities they underwrite • Underwriting is typically conducted through a syndicate which includes many investment banks and brokerage firms

  23. Securities Brokers and Dealers and Investment Banks Investment banks • Investment banks derive a substantial amount of income from offering advice to firms involved in mergers and acquisitions • What price one firm should pay for another • How the transaction should be structured • Provide strategic advice in hostile takeovers—when one firm seeks to acquire another against the other’s wishes

  24. Securities Brokers and Dealers and Investment Banks Brokers and Dealers • Involved in the secondary market, trading outstanding securities • Brokers match buyers and sellers and earn a commission • Dealers commit their own capital when the buying and selling of securities and hope to make profit on the transaction

  25. Securities Brokers and Dealers and Investment Banks • Brokers and Dealers • Many of the nationwide stock exchange firms act as investment bankers, dealers, and brokers • Commercial banks, investment banks, and broker dealers have now combined under single holding company umbrellas

  26. Venture Capital Funds • Venture capital funds, mezzanine debt funds, and hedge funds are usually not available to public investors and not registered with SEC • Funding comes from wealthy individuals or other financial institutions, possibly sponsored by brokerage firms and banks • Both venture capital funds and mezzanine debt funds provide an important source of funding to small and midsize companies • Financing by both venture and mezzanine funds is non-traded and held until maturity

  27. Venture Capital Funds Venture Capital Funds • Invest funds in start-up companies • Traditional bank financing for these firms in the early stage of growth would be very limited • The Venture Capital Fund takes a substantial equity stake in the firm • Although many start-up companies not successful, significant profit can be made on those that are successful • Receives profits when it takes the successful company public in an Initial Public Offering (IPO).

  28. Mezzanine Debt Funds • Mezzanine Debt Funds • Provide debt funds to small and midsize companies • Issue convertible debt and subordinated debt • Sometimes simply invest in a combination of high-yielding debt and equity issued by the same company • Used to provide long-term funds, sometimes part of a management-buyout financing package

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