FI Basics Flashcards
Term for excluding potential financial service customers from the marketplace
Redlining
Define Agency Costs
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
Protection against the risk of FI failure is a function of
Safety and soundness regulation
The Central Bank directly controls the portion of money know as
Outside money
Actions that utilize the money supply in an effort to impact macroeconomic activity
Monetary policy
FI functions
Brokerage
Asset Transformation
Payment services
Asset definition
Resource with economic value with the expectation that it will provide a future benefit
Ease of converting an asset into cash
liquidity
Asset Transformer
FI issues financial claims that are more attractive to household savers than the claims directly issued by corporations
Primary securities
Securities issued by corps and backed by real assets
Difference between private costs of regulations and the private benefits for the producers of financial services
Net regulatory burden
Money supply directly produced by the government or central bank, such as notes or coins
Outside Money
Money supply produced by the private banking system
Inside money
Six major types of FI regulations
Safety and Soundness Monitory policy Credit allocation Consumer protection Investor protection Entry and chartering
Shadow banks
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
Moral hazard definition
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.
Tri party repo (repurchase) agreement
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.
Adverse Selection definition
A problem in that customers who apply for insurance policies are more likely to be those most in need of insurance
Liquidity
Ease of converting an asset into cash
The ability to trade large quantities on short notice without moving the price
Price Risk
Risk that the sale of an asset will be lower than the purchase price of that asset.
Interest Rate Risk
Risk incurred when the maturities of its assets and liabilities are mismatched
Credit Risk
Risk that promised cash flows from loans and securities held by FI may not be paid in full
Liquidity Riak
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
Market Risk
Risk incurred from assets and liabilities Ina trading book due to charges in interest rates, exchange rate, and other prices
Insolvency Risk
Risk that an FI may not have enough capital to offset a sudden decline in the value of its assets
Gresham’s Law
‘Bad money drives out good.’
Definition of value
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.
The four cornerstones of finance
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.
- Value is created when companies generate higher cash flows. Called conservation of value.
- 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. - Value of a business depends on who is managing it the strategy it uses.
Value relative to who owns it and operates it.
Return on Invested Capital (ROIC)
After tax operating profit divided by invested capital (working capital plus fixed assets)
Define real and nominal interest rates
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
