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Financial Markets and Institutions – BA 543

Financial Markets and Institutions – BA 543. Thursday Bexell 415 12:00 noon to 2:50 p.m. 6:00 p.m. to 8:50 p.m. Chapter 2 – Financial Intermediation. Definition of Financial Intermediation Transforming financial assets into more widely preferred type of asset/liability Example: Car Loan

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Financial Markets and Institutions – BA 543

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  1. Financial Markets and Institutions – BA 543 Thursday Bexell 415 12:00 noon to 2:50 p.m. 6:00 p.m. to 8:50 p.m.

  2. Chapter 2 – Financial Intermediation • Definition of Financial Intermediation • Transforming financial assets into more widely preferred type of asset/liability • Example: Car Loan • Example: Swap (Bond swap from fixed to floating rate) • Performed by Financial Institutions • Many of these intermediation functions are completed with large institutions • Completed in Financial Markets

  3. Chapter 2 – Financial Intermediation • A closer look at Financial Institutions • Types • Banks – Commercial, Investment, Savings and Loans, Credit Unions, etc. • Investment Companies • Insurance Companies • Others – Pension Funds, Foundations, etc. • Functions • Transforming, Exchanging, and Designing Financial Assets • Advising and Managing Financial Assets

  4. Chapter 2 – Financial Intermediation • Direct Investing with Intermediaries • Commercial Bank • Direct Deposit – CD – Promised Payment at the end of the Investment Period • Dollars are loaned to a borrower (to buy a car) with a different payment schedule • Indirect Investing with Intermediaries • Mutual Fund Company (Investment Company) • Buy mutual fund shares at NAV (no load) • Company uses funds to buy stocks and bonds

  5. Chapter 2 – Financial Intermediation • Four Functions of Intermediation • Maturity • Borrow in the long, lend in the short • Risk Reduction (Diversification) • Eliminate firm specific risk via a portfolio • Cost Reduction of Information/Contracting • Share information acquired across large set of individuals • Payment Mechanisms • Checks, Credit Cards, Debit Cards, etc.

  6. Chapter 2 – Financial Intermediation • Asset/Liability Management for Financial Institutions • Nature of Business – Buy and Sell Money • Buy Low, Sell High – Spread • Nature of Liabilities • Timing and Amount of Outflow of Cash • Table 2-1 Page 19 • Liquidity of Claims against Financial Institutions – can obligations be met with current assets of the institution?

  7. Chapter 2 – Financial Intermediation • Growth of Financial Intermediaries through Financial Innovation • Market Broadening Instruments – attracts new investors • Zero-Coupon Bonds – TGIRS, LYONS, etc • Risk Management Instruments • Options • Arbitrage Instruments – Price Stability • Index Assets for direct trade • Motivation? Risk Transfer or Arbitrage

  8. Chapter 2 – Financial Intermediation • Asset Securitization • Pledging Cash Flows from a set of borrowers to the lenders of the funds… • Example Mortgage Backed Securities • Ginnie Mae, Sallie Mae, Freddie Mac… • Conforming Loans are the security for the Bonds sold to investors and the payment of the mortgage payment flows to bondholders • Original Lender to Mortgage does not service loans – just pools loans and sells bonds • Costs and Benefits? Implications?

  9. Chapter 2 – Financial Intermediation • End of Chapter Questions • #7 – Mutual Funds – Advantages and Disadvantages for Investor • Advantages • Risk Reduction – Portfolio • Cost Reduction for information and transactions • Record Keeping • Disadvantages • Loss of flexibility for individual investor • Pay gains annually stock appreciation • Conclusion – Meets the needs of many investors thus the growth…

  10. Chapter 2 – Financial Intermediation • End of Chapter Questions • #8 – Volatility Increases Innovation • Greater Volatility means Greater Risk • Greater Risk means Benefits of Risk Transfer Increases • Financial Innovation is finding an efficient way to transfer risk so greater volatility increases the benefits of new ways to transfer risk. • #10 – Asset Securitization and Liquidity • Liquidity of Market (instruments have a secondary market) • New Lenders that find “niche” meets their requirements

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