Fabozzi Chapter 2

Front 1

what types of financial intermediaries are there (name 5)?

Back 1

commercial banks, saving and loan associations, investment companies, insurance companies, pension funds

Front 2

what are the three main innovations in finance?

Back 2

1. sophisticated telecommunication
2. globalization of business + finance
3. securitization- pool traditional assets and sell securities backed by these loan pools in the capital markets

Front 3

what services do financial institutions provide (6)?

Back 3

1. transform financial assets acquired in market and constitute them into a type of asset (think commercial bank where people deposit money that becomes the bank's liability)
2. exhange of financial assets on behalf of customers; broker/dealer
3. exchange of financial assets for own accounts; broker/dealer
4. create assets for customers, then sell them to other market participants (underwriting)
5. provide investment advice to other market participants
6. manage the portfolios

Front 4

name 7 depository institutions.

Back 4

1. commercial banks
2. savings and loan associations
3. savings banks
4. credit unions
5. insurance companies
6. pension funds
7. finance companies

Front 5

what is a captive finance company?

Back 5

nonfinancial enterprises create subsidiaries that provide financial services for its customers

Front 6

what are direct investments?

Back 6

financial intermediaries get money (liability) and then invest it in loans or securities- which become their assets

Front 7

what are indirect investments?

Back 7

market participants who give their money to financial intermediaries that go on to invest it are making indirect investments

Front 8

what does a commercial bank do?

Back 8

accepts deposits and uses proceeds to lend funds to consumers and businesses

Front 9

what does an investment company do?

Back 9

pools the funds of market participants and uses those funds to buy a portfolio of securities- stocks and bonds; investor recieves equity- a pro rata share of the outcome of the portfolio

Front 10

financial intermediaries transform financial assets making these assets more preferable to society. how (4)?

Back 10

1. providing maturity intermediation
2. reducing risk via diversification
3. reducing the costs of tracting and information processing
4. providing a payment mechanism

Front 11

what is the benefit of maturity intermediation?

Back 11

1. investors have more choices concerning maturity for their investments; borrower has more choices for when they have to pay their debt
2. borrow pays lower longer-term rate on loans than if an individual investor offered it b/c bank can count on successive deposits

Front 12

what is diversification and its benefit?

Back 12

transforming risky assets into less risky assets; investors with a small sum of funds cannot invest in a large number of companies like an investment company can

Front 13

how do financial intermediaries reduce the costs of contracting and information processing?

Back 13

financial intermediaries have economies of scale in contracting and processing information because of the amount of funds they manage; tough for an individual to write a loan contract, acquire information necessary to invest (think opportunity cost, enforcing contract cost, information processing cost, contracting costs)

Front 14

how do payment mechanisms benefit individuals?

Back 14

financial intermediaries allow people to make payments without the use of cash- this is critical for the functioning of a financial market

Front 15

what is the difference between a credit card and a debit card?

Back 15

credit card- bill at the end of the month
debit card- money immediately withdrawn

Front 16

why are depository institutions considered spread businesses?

Back 16

because there objective is to sell money for more than it costs to buy money

Front 17

what institutions are considered spread businesses and which are not?

Back 17

spread-
commercial banks, life insurance companies (to a certain extent property and casualty insurance)
not spread-
pension funds (do not raise funds themselves in the market)
investment companies (no explicit costs for funds, no liability obligations unless investment company agrees to repurchase shares)

Front 18

what do the liabilities of a financial institution mean?

Back 18

the amounbt and timing of the cash outlays that must be made to satisfy contractual terms

Front 19

how many types of liabilities to financial institutions have?

Back 19

4

Front 20

what is a type-1 liability?

Back 20

amount of cash to be payed is known
timing of payment is known
depository institutions + insurance companies can sell them
ex: liability forces financial institution to pay $50,000 six months from now

Front 21

what is a type-2 liability?

Back 21

payment is known
date of payment is unknown
ex: life insurance policy- payed upon death

Front 22

what is a type-3 liability?

Back 22

payment is unknown
date of payment is known
ex: depository institution issues a CD (certificates of deposit); with a floating-interest rate and a stated maturity

Front 23

what is a type-4 liability?

Back 23

payment is uncertain
date of payment is uncertain
ex: automobile/home insurance policies; pension plans (depend on when you retire; how much you earn a year)

Front 24

what three financial innovation categories does the Economics Council of Canada classify?

Back 24

1. market-broadening instruments: increase liquidity and availability of funds
2. risk-management : reallocate risk
3. arbitraging instruments and processes: allows investors and borrowers to take advantage of differences in costs and returns between markets

Front 25

what five financial innovation categories does the Bank for International Settlements classify?

Back 25

1. price-risk transfering innovations
2. credit-risk transfering instruments
3. liquidity-generating innovations
4. credit-generating instruments
5. equity-generating instruments

Front 26

what two classes of financial innovation does Stephen Ross classify?

Back 26

1. new financial proucts (financial assets and derivative instruments) better suited for circumstances of time (inflation)
2. strategies to use these products

Front 27

what are the two conflicting views on financial innovation?

Back 27

1. avoiding regulations
2. more efficient ways of distributing risk

Front 28

Causes of financial innovation?

Back 28

1. increased volatility of interest rates, inflation, equity prices, exchange rates
2. advances in technology
3. more sophisticated/better trained participants
4. financial intermediary competition
5. incentives to get around regulations
6. changing global patterns of wealth

Front 29

what is asset securitization?

Back 29

pooling of loans to create sellable securities backed by loans; make illiquid assets (contracts) sellable; more than one institution is involved; commercial bank does not have to absorb credit risk, service the loan or provide funding

Front 30

what are the benefits to issuers of asset securitization?

Back 30

1. cheaper funding sources through diversification
2. management of regulatory capital; manage risk
3. generates servicing fee; by selling the security it creates a new fee without having to increase its capital base
4. management of interest rate volatility; can securitize assets that expose institutions to volatile interest rates

Front 31

what are the benefits to investors of asset securitization?

Back 31

1. backed by pool of loans
2. credit enhancement; less risk

Front 32

what are the benefits to borrowers of asset securitization?

Back 32

1. more liquid assets to sell
2. competition lowers prices

Front 33

what is denomination intermediation?

Back 33

transfering very large assets in divisible ones; allows bank to make large loans financed by small dollar investors

Front 34

what is off-balance sheet financing?

Back 34

bank does not need its own assets to finance credit

Front 35

what is a social benefit of asset securitization? example.

Back 35

1. viatical settlement- allows say an AIDs patient to sell his life insurance policy