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7 th Session

7 th Session. 3. Certificate of Deposit Issued by a bank to certify that the depositor has deposited a certain sum of money at the bank. Characteristics Large denominations ($100,000, $1M, $10 M) Interest payment Maturity (up to 1 year) Typical Issuer: Commercial bank

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7 th Session

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  1. 7th Session

  2. 3. Certificate of Deposit • Issued by a bank to certify that the depositor has deposited a certain sum of money at the bank. • Characteristics • Large denominations ($100,000, $1M, $10 M) • Interest payment • Maturity (up to 1 year) • Typical Issuer: Commercial bank • Typical Investor: Institutional Investors • Term security • Bearer Instrument (holder of instrument is owner and entitled to coupon payment) • Negotiable (can be bought and sold in secondary market)

  3. 4. Commercial Paper • Issued by well-known corporations for short term financing obligations. • Characteristics • Typical Investor: Institutional investors • Discount Investment • Direct Placement • Bearer Instrument • Unsecured loan • Riskiness (investor can gauge possible riskiness by looking at the credit rating of the issuing corporation)

  4. 5. Banker’s Acceptance • Short term debt instrument guaranteed for payment by a commercial bank. • Bank ‘accepts’ the responsibility to pay. • Characteristic • Typically arises in International trade where the two companies do not know about each other (located at different geographical areas).

  5. 6. Eurodollar • Euro means a ‘foreign country’. • Refers to US dollar deposit in a foreign country. • Characteristics • Maturity • Interest payment • EuroYen

  6. 8th Session

  7. 7. Repo (Repurchase Agreement) • Sale of government securities with an immediate agreement to buy them back on a future date at a specified price. • Characteristics • Secured loan • Time (Overnight – some are long term)

  8. Capital Market Instruments • T-Bonds and T-Notes • Long term debt security • Issued by government • PIB • Maturity: T-Notes (2-10 years) T-Notes (10-30 years) • Fixed Interest payment • Principal payment upon maturity • Government is the borrower • Risk (Riskier than T-bills)

  9. 2. Corporate Bonds • Long term debt security • Issued by corporation • Maturity (2-30 years) • Fixed interest payment • Risk (credibility) • AAA rated bond: risk (low) return (low) • B rated bond: risk (high) return (high)

  10. 3. Mortgages • Loan made to purchase real estate with the real estate serving as collateral for the loan. 4. Common Stock • Share of ownership • Dividends • Variable

  11. 5. Preferred Stock • Hybrid security (characteristics of both bond and stock instruments) • Characteristics similar to bond: • Fixed dividend payment • Paid before common stockholders • Characteristics similar to stock: • Generally listed on a stock exchange • No fixed maturity date

  12. 9th Session

  13. The Importance of Financial Intermediaries in Financial Markets Direct Finance Transaction Costs Asymmetric Information cost

  14. 1. Transaction cost • How Transaction cost adversely impacts direct financing transactions? • Definition • Time and Search costs • Legal costs • Monitoring and enforcement costs • How can a financial intermediary reduce transaction cost? • Economies of scale • Expertise

  15. 2. Asymmetric Information • Definition • Types • Adverse selection • Moral Hazard • How can a financial intermediary reduce asymmetric information cost? • Financial intermediaries, particularly banks, specialize in gathering information about the default risk of borrowers. Among the tools used are credit reports. • Commercial banks specialize in monitoring borrowers and have developed effective techniques for ensuring that the funds they loan are actually used for their intended purpose.

  16. Financial Intermediaries • Depository institutions • Commercial banks • Saving and Loan associations • Mutual savings banks • Credit Unions • Contractual saving institutions • Life Insurance companies • Fire and casualty insurance • Pension funds • Investment companies • Finance companies • Mutual funds • Money market mutual funds

  17. 10thSession

  18. Ensuring the soundness of Financial Intermediaries • Restrictions on entry • Federal charter, upright citizens with large amount of funds • Disclosure requirements • Must make certain information public, book of accounts subjected to regular inspection • Restrictions on assets and activities • Restriction from holding common stock • Deposit insurance • Deposit insured by the federal government • Limits on competition • Limited number of branches • Restriction on Interest rates

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