FI Basics

Question 1

Term for excluding potential financial service customers from the marketplace

Answer 1

Redlining

Question 2

Define Agency Costs

Answer 2

Risk that owners and managers will take that are in their best interests but knowingly not in the best interest of the firm or savers

Question 3

Protection against the risk of FI failure is a function of

Answer 3

Safety and soundness regulation

Question 4

The Central Bank directly controls the portion of money know as

Answer 4

Outside money

Question 5

Actions that utilize the money supply in an effort to impact macroeconomic activity

Answer 5

Monetary policy

Question 6

FI functions

Answer 6

Brokerage
Asset Transformation
Payment services

Question 7

Asset definition

Answer 7

Resource with economic value with the expectation that it will provide a future benefit

Question 8

Ease of converting an asset into cash

Answer 8

liquidity

Question 9

Asset Transformer

Answer 9

FI issues financial claims that are more attractive to household savers than the claims directly issued by corporations

Question 10

Primary securities

Answer 10

Securities issued by corps and backed by real assets

Question 11

Difference between private costs of regulations and the private benefits for the producers of financial services

Answer 11

Net regulatory burden

Question 12

Money supply directly produced by the government or central bank, such as notes or coins

Answer 12

Outside Money

Question 13

Money supply produced by the private banking system

Answer 13

Inside money

Question 14

Six major types of FI regulations

Answer 14

Safety and Soundness
Monitory policy
Credit allocation
Consumer protection
Investor protection 
Entry and chartering

Question 15

Shadow banks

Answer 15

Non-financial service firms that perform banking services. Enabled the originate and distribute model
Result of Financial Services Moderizatiin Act of 1999
Participants: structured investment vehicles (SIVs), special purpose vehicles (SPVs), asset back paper vehicles, credit hedge funds, money market mutual funds

Question 16

Moral hazard definition

Answer 16

Moral hazard is the risk that a party to a transaction has not entered into the contract in good faith, has provided misleading information about its assets, liabilities or credit capacity, or has an incentive to take unusual risks in a desperate attempt to earn a profit before the contract settles

The loss exposure faced by an insurer when the provisions of the insurance encourages the insured to take more risk.

Question 17

Tri party repo (repurchase) agreement

Answer 17

In a repurchase, or “repo”, transaction, an investor can borrow cash for a short period from another party, using securities as collateral for the loan.

Question 18

Adverse Selection definition

Answer 18

A problem in that customers who apply for insurance policies are more likely to be those most in need of insurance

Question 19

Liquidity

Answer 19

Ease of converting an asset into cash

The ability to trade large quantities on short notice without moving the price

Question 20

Price Risk

Answer 20

Risk that the sale of an asset will be lower than the purchase price of that asset.

Question 21

Interest Rate Risk

Answer 21

Risk incurred when the maturities of its assets and liabilities are mismatched

Question 22

Credit Risk

Answer 22

Risk that promised cash flows from loans and securities held by FI may not be paid in full

Question 23

Liquidity Riak

Answer 23

Risk that a sudden change in liability withdraws may require a FI to liquidate assets in a very short period of time and at less than fair market prices

Question 24

Market Risk

Answer 24

Risk incurred from assets and liabilities Ina trading book due to charges in interest rates, exchange rate, and other prices

Question 25

Insolvency Risk

Answer 25

Risk that an FI may not have enough capital to offset a sudden decline in the value of its assets

Question 26

Gresham’s Law

Answer 26

‘Bad money drives out good.’

Question 27

Definition of value

Answer 27

Purest form: sum of the present values of future expected cash flows. Point in time measurement.

Value creation: change in value to to company performance.

Question 28

The four cornerstones of finance

Answer 28

Four cornerstones of value
1. Companies create value by investing capital from investors to generate future cash flows at rates of return that exceed the cost of the capital. Rate the investors require to use their capital.
Combo of growth and Return on invested capital (ROIC) drives value and value creation.
Return on invested capital (ROIC)- operating profits divided by the capital invested in fixed assets, working capital and other assets.

2. Value is created when companies generate higher cash flows. Called conservation of value.
3. Company’s stock market performance based upon changes in expectations, not just performance. Called expectations treadmill.
   Wise saying: Good companies aren’t necessarily good investments.
4. Value of a business depends on who is managing it the strategy it uses.
   Value relative to who owns it and operates it.

Question 29

Return on Invested Capital (ROIC)

Answer 29

After tax operating profit divided by invested capital (working capital plus fixed assets)

Question 30

Define real and nominal interest rates

Answer 30

Nominal- growth rate of money
Real- growth rate of purchasing power.

Estimate of real rate of return
rr= rn-i

rr - real
rn - nominal
i- inflation

Exact
rr = rn-i/1+i