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Bank > 5 - Ec R of Banks > Flashcards

5 - Ec R of Banks Flashcards

1
Q

What is the primarily role of a bank?

A

Take in funds (called deposits), pool them and lend them to those who need funds

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2
Q

What will you not find under a banks balance sheet?

A

Inventory
Accounts Receivable
Accounts Payable

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3
Q

How is a banks balance sheet different to a typical company?

A

You won’t find:
Inventory
Accounts Receivable
Accounts Payable

You will mostly see:
Assets:
• Loans: Banks provide loans to customers
• Investments: Banks invests in various financial instruments, such as government bonds, corporate bonds and securities

Liabilities:
• Deposits: Customers deposit money into their accounts at a bank which is recorded as a liability
• Borrowing: Banks may borrow money from other financial institutions or issue bonds

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4
Q

Why does banks have cash and cash equivalent in the balance sheet?

A

Generally, for liquidity reasons

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5
Q

Loans in the balance sheet represent

A

Represents majority of banks assets.

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6
Q

Bank: Loan versus securities

A

Can typically earn a higher interest rate on loans than on securites

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7
Q

What is PP&E in the balance sheet, and how big will it be?

A

Property, Plant and Equipment.

Usually only a small fraction of the assets

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8
Q

What is goodwill in the balance sheet?

A

Typically reflects the value of intangible assets, like:
a) Strong brand name
b) good customer relations
c) good employee relations

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9
Q

What is Off-Balance Sheet (OBS)?

A

Assets or liabilities that do not appear on a company’s balance sheet, but that are nonetheless effectively assets or liabilities in the company.

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10
Q

Example of typical Off-Balance Sheet (OBS)

A

Some loans are securitized and sold off as investments. The securitized debt will be kept off the banks books (operating lease is one of the most common off-balance items)

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11
Q

How does a bank typically categorize their revenue

A

1) Interest Income
2) Non-Interest Income

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12
Q

What is the “spread” for a bank

A

The difference in interest that a bank earn on loans and paid to their depositors

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13
Q

How does banks earn a non-interest income?

A

Provide a variety of value-added serviced like
a) Trading of securities
b) commissions on securities
c) assisting companies to issue new equity financing
d) Wealth management

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14
Q

What are reserve requirements?

A

A regulation from the central bank.

A commercial bank must hold a minimu amount of liquid cash (normally in a bank vault)

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15
Q

Why are banks required to hold reserves?

A

If many depositors withdraw their money before the loan due date, it might be difficult for the bank to fill the withdrawal.

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16
Q

What is capital requirement?

A

The amount of capital a bank or other financial institutions has to hold as required by its financial regulator.

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17
Q

How are capital requirements usually expressed?

A

As a capital adequacy ratio of equity tht must be held asa percentage of risk-weighted assets

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18
Q

Four brackets of typical bank services

A

Individual banking
Business banking
Digital Banking
Loans

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19
Q

What is individual banking

A

Services to assist individuals in managing their finances

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20
Q

What is individual banking

A

Services to assist individuals in managing their finances

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21
Q

examples of individual banking

A

Checking accounts
Savings account
Debit credit cards
Insurance
Wealth management

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22
Q

What is business banking

A

Offer financial services for business owners who need to differentiate professional and personal finance

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23
Q

Example of business banking

A

Checking accounts
Savings account
Debit and credit cards
Merchant services
Cash management

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24
Q

What is digital banking?

A

The ability to manage your finances from your computer, tablet, or smartphone. The use of technology

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25
Q

Some different types of loans?

A

1) Personal loans
2) Home equity loans
3) Home equity lines of credit
4) Home loans
5) Business loans

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26
Q

What are the two major types of financial markets where firms can borrow money in form of debt?

A

1) Bank loan markets
2) Capital markets

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27
Q

What are capital markets?

A

Markets for buying and selling equity and debt instruments

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28
Q

How do we split up the capital market?

A

a) Primarily markets: Where stock and bond issues are sold to investors
b) Secondary markets: Trading of existing securities

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29
Q

What are the main differences between bank lending and capital markets?

A

1) A regular bank is not securitized
2) Lending from banks and similar institutions is more heavily regulated than capital market lending
3) Bank depositors tend to be more risk averse than capital market investors

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30
Q

What is the predominat source of external funding in all countries? What is the role of capital markets in this?

A

Bank loans. Capital markets have never been a significant source of financing and equity markets are insignificant

31
Q

What is a bond?

A

Instrument of debt of the bond to the holders. A debt security, under which the ssuer holds a debt and, depending on the terms of the bond, is obliged to pay them interest (coupon) and/or to repay the principal at a later date

32
Q

Major difference between stocks and bonds?

A

Both are securities

Main difference: (Capital) stockholders have an equity stake in a company (investors) whereas bondholders have a creditor stake in the company (lenders)

33
Q

Who has priority of bondholders and stockholders?

A

Bondholders are creditors, and have a priority over stockholders. They will get repaid in advance.

34
Q

Fixed Rate Bond

A

Coupon that remains throughout the life of the bond

35
Q

Floating Rate Notes (FRNs, Floaters)

A

Variable coupon linked to a reference of interest, such as LIBOR or Euribor

36
Q

ZCBs

A

No regular interest. Issued at a substantial discount to par value, so that the interest is effectively rolled up to maturity

37
Q

High-yield bonds (junk bonds)

A

Bonds that are rated below investment grade by the credit rating agencies. As these bonds are riskier, investors expect a higher return

38
Q

Convertible bonds

A
  • Lets a bondholder exchange a bond to a number of shares of the issuers common stock.
  • Typically known as hybrid securities, because they combine equity and debt features
39
Q

inflation-indexed bonds

A

Principal amount and interest payment are indexed to inflation.

Interest rate is normally lower than for fixed rate bonds with comparable maturity. However, as the principal grows, the payments increase with inflation

40
Q

Subordinated bonds

A

Bodns that have a lower priority than other bonds of the issuer in case of liquidation. Lower ranked in the hierarchy on who gets paid first. Yields higher risk, and will usually have a lower credit rating

41
Q

In case of bankruptcy, when does the subordinated bondholders get paid? Explain the hierarchy

A

1) First the liquidation is paid
2) then the holders of senior bonds get paid
then the subordinated bondholders get paid

42
Q

Government bonds

A

Also called Treasury bonds. Issued by a national government and is not exposed to default risk. Is characterized as the safest bond - with the lower interest rate

43
Q

What is lines of credit?

A

A borrowing limit is extended to a customer, and funds can be borrowed again later after the money is repaid

44
Q

What is revolving credit?

A

Type of credit that basically is an arrangement allowing for the loan amount to be withdrawn, repaid, and withdrawn again in the manner and any number of times, until the arrangement expires

45
Q

Examples of revolving loans?

A

Credit card loans
Overdrafts

46
Q

Difference between Bank Loans and Bonds: Revolving Concentrated vs. dispersed lenders

A

A bond typically has thousands of holders while a bank loan only have one or a few (syndicate) as lenders

47
Q

What are the two types of covenants?

A

Financial covenants
Negative covenants

48
Q

What are financial covenants?

A

Require the borrower to maintain certain financial ratios or performance measures.

Often:
Leverage
Debt-to-EBITDA ratio.

49
Q

What are negative covenants?

A

Restrict borrower from certain actions such as
* excessive investments,
* distribution of dividends,
* asset sales,
* change in company control,
* misuse of cash flows etc.

50
Q

What is the simplest way to justify the existence of banks?

A

Reduce transaction costs

51
Q

Transaction costs include two different types of costs:

A

Observable costs (e.g., travelling, time and effort)
Unobservable costs (e.g., agency costs)

52
Q

What do we mean by economies of scale?

A

The reduction in the average costs (cost per unit) associated with increasing the scale of production for a single product type.

53
Q

What do we mean by economies of scope?

A

Lowering the average cost for a firm in producing two or more products (Example, Mcdonalds; fries & burger)

54
Q

How can banks reduce transaction costs?

A

a) Economies of scale
b) Economies of scope
c) Digitalization
d) Regulation and supervision of banks by the authorities

55
Q

Compared to small lenders/borrowers, banks will save money from economies of scale by having less costs of:

A

Searching or matching,
screening,
contracting,
negotiation,
diversification,
monitoring

56
Q

How will banks save money due to economies of scope?

A

INFORMATION.

Enjoy access to privileged information, and can evaluate borrowers creditworthiness

57
Q

Banks advantage in relationship lending?

A

Economies of scope:
1) Lend to same firm over time, sthrengtens relationship and customer loyalty.

2) Custommer has specialized financial products designed from demographics, such as students, seniors or the wealthy.

58
Q

Customers advantage when it comes to commercial banks

A

The authorities look over the behavior of the banks. So the customers dont have to spend resources on it

59
Q

How does a bank reduce transaction costs when it comes to searching and matching?

A

Hire professionals
Employs advanced equipmend
Repeatedly conducting the searching or matching process

60
Q

Why do banks exist?

A

Diversification

61
Q

Explain diversification

A

A risk management technique that mixes a wide variety of investments within a portfolio

62
Q

What are the two general techniques for reducing risk?

A

Diversification
Hedging

63
Q

What are the four main functions of a bank

A

1) Offer liquidity and payment services
2) Transforming assets
3) Managing risks
4) Processing information and monitoring borrowers

64
Q

What is commodity money, or fiat money?

A

Money without an intrinsic value. Not backed by gold etc.

65
Q

How does a bank transform assets?

A

a) Banks choose the unit size (denomination) of its products (deposits and loans)
b) Risk transformation
c) Maturity transformation

66
Q

Explain Transforming assets: convenience of denomination

A

Match small deposits with large loans and large deposits with small loans.

Without a bank, lenders and borrowers have to match by themselves. Banks are more professional to do the job due to economies of scale & scope

67
Q

Explain Transforming assets: Risk transformation

A

Banks deposits better risk-return characteristics than direct investments because of:

a) Risk management: small investors cannot diversify their portfolios
b) asymmetric information: banks have better information or expertise than depositors

68
Q

Explain Transforming assets: Maturity transformation

A

Transformi ng short-term liabilities into long-term assets. This is the source of interest rate risk and liquidity risk

69
Q

What are the traditional sources of risk affecting banks

A

1) Credit Risk
2) Interest rate risk and liquidity risk
3) Off-balance-sheet operations

70
Q

Explain a banks Credit Risk

A

Risk that aa borrower is not able to repay its debt

71
Q

How will a bank try to limit the Credit Risk?

A

Collateral
Diversification

72
Q

Explain the banks interest rate risk and liquidity riskn

A

Cost of funds may rise above the interest rates that are granted by the bank

Unexpected withdrawals of deposits may force banks to seek more expensive sources of funds

73
Q

What are the banks risks when it comes to Off-Balance-Sheet Operations

A

This usually means an asset or debt or financing activity that are not in the company’s balance sheet

Bank (13 decks)

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