Fin 4319-Lecture 2

Question 1

What do people who invest in Real assets require?

Answer 1

They require a huge amount of money.

Question 2

What are the stages of operational efficiency?

Answer 2

Market for indirect lending

Question 3

What is Direct lending?

Answer 3

NA

Question 4

What is planning?

Answer 4

SSU’s match DSU’s

Financial middlemen

Question 5

What are 2 types of Financial middlemen?

Answer 5

Brokers and Dealers

Question 6

What is a Dealer?

Answer 6

Dealer: “market maker”. Stands willing to buy and/or sell at the bid/ask spread. They provide liquidity.

Example: Bid 7.00 Ask 7.25
“Intermediary of transaction”; $.25 goes to Dealer’s pocket

If you want to buy, you have to buy at 7.25 and sell at 7.00. If you don’t want to buy at 7.25 you have to put a lower bid using a limit order at 7.10, and you may wait forever. If you want to get the deal done, you have to pay the spread at 7.25. If the spread is too wide other dealers will come in and put in bids.

Question 7

What is a Broker?

Answer 7

Broker: match buyer and seller, and charges a commission

They reduce search costs and facilities capital formation.

They are neither SSU or DSU.

Question 8

What 3 ways do Dealers make money?

Answer 8

1. They make money on the bid /ask spread
2. “on the carry”
3. if dealers thinks they know what will happen to the price of an asset they can speculate by buying or shorting

Question 9

What are Primary markets and Secondary markets?

Answer 9

The primary market is where securities are first issued to public and Secondary market is trading of securities after issuance in Primary Market.

Question 10

What is an Investment Bank?

Answer 10

Primary Market Middlemen, The help facilitates the issuance of mostly bonds or IPO (more rare when new companies go public.)

Question 11

What is an Underwriter?

Answer 11

Investment banker. Dealer. They operate on the spread. They will buy the entire bond issuance and will sell it to public. They’ll pay 98 and will sell to public at 100. This is a Primary Market / direct transaction.

Question 12

What is “price discovery mechanism”

Answer 12

Feedback loop to primary market

Reduce risk to underwriter

Question 13

What is Indirect lending?

Answer 13

“FI”

Question 14

What are examples of Financial Intermediary?

Answer 14

Involved in indirect lending.
Commercial Bank, Savings and Loans, Credit Unions
Finance Companies makes loans
Insurance (Life/Health/Property) - invest in financial assets(bonds).
Pensions
Investment Company

Question 15

How are Pensions defined?

Answer 15

Defined Benefit. You work for 30 years and after you retire, the company pays for 60% of your last years of salary for the rest of your life. These are no longer given and underfunded. The major city pensions are going to blow up except for Texas. It’s in the trillions of dollars and no body is safe for retirement.

Question 16

How are 401k/ 403b defined?

Answer 16

Defined Contribution

Question 17

What are closed end funds?

Answer 17

Investment companies provide funds that trade on the exchange

Question 18

What are open ended funds?

Answer 18

Investment companies sell Mutual funds

Question 19

Can you be a saver and still be a DSU?

Answer 19

Yes, it’s compared to what happened to real assets on your balance sheet.

Question 20

If you have extra savings, what can you invest in?

Answer 20

Real or Financial assets

Question 21

If you didn’t have financial markets, where would your savings go?

Answer 21

Real assets. Most people don’t have access to super productive real assets. You could farm, open a restaurant, motel, drill an oil well, make a new iPhone. Real assets require huge amount of money.

Some people have great ideas for real asset investments, but they don’t have the money to do it.

Question 22

Some people don’t understand the value of Financial markets, what’s the real key value of Financial markets?

Answer 22

There will be more efficient capital formation in the economy. Savings will get channelled to the most productive investments.

Question 23

What is the definition of Greed?

Answer 23

If you rather have 1 more dollar than 1 less dollar

Question 24

What are not financial intermediary?

Answer 24

Brokers and dealers

Question 25

What was the Glass Stegal Act?

Answer 25

It’s an old law that required banking and investment to be separate businesses. The law was repealed in 1993 so that Citibank could buy Travers (investment co).

Question 26

What is a FI?

Answer 26

Financial institution

Question 27

What’s the risk for dealers?

Answer 27

The price may go away from the bid and ask prices.

Question 28

What is “carry trade”?

Answer 28

Dealers carry inventory of financial assets that generates cash inflow. For example, If you hold treasury bonds, holding the bonds gives the coupon / interest. They can pay for the inventory by borrowing money market via repo agreements that have interest rates that are lower then the treasury bonds. “carry trade” -> think about risk. Treasury bonds 3.5% and the rate on money market, nearly 0% so you make the difference. It is risky if the interest rates go up on the money market or bonds go below.

Question 29

What is the Japanese Carry trade?

Answer 29

Borrow money market in japan and buy securities in Australia which have higher interest.

Question 30

What is Public funds investment act, Texas (1995)?

Answer 30

Bob Citron, treasurer, bankrupted Orange county trying to make the carry trade so they made it illegal in Texas.

Question 31

Which is harder bond or stock market?

Answer 31

Bond market, you can specify and quantify risk and you can tell when someone is doing something inappropriate. Firms who hire fixed income will get paid more money than equities (stocks). You have to be very smart to work in fixed income.

Question 32

How do companies get money to do business?

Answer 32

They call wallstreet to sell some bonds. Financial middle facilitie issuance of

Question 33

What is Underwriting on best efforts?

Answer 33

Investment bank. Broker. When an underwriter does not guarantee the purchase of all bonds.

Question 34

What would happen if there’s no secondary market?

Answer 34

For 30 year bonds, If you finance a long term project with a short term loan, you have to refinance too much, you don’t know what the interest will be from 30 years from now so you don’t know the cost of capital. If there’s a credit crisis you may be not be able to issue commercial paper. You won’t be able to refinance your long term project, so you have to sell your fixed assets or file for bankruptcy. So businesses issue 30 year bonds.

Question 35

Who would buy 30 year bonds if there’s no second markets?

Answer 35

Pension funds, life insurances, but not many people. Individual investors would have to wait 30 years to get interest. You may get emergency and need moeny so you be reluctant to buy that 30 year bond.

Question 36

What’s the value of secondary market?

Answer 36

1. Lower cost of capital
2. More investments, more jobs
3. Liquidity allows you to get in and out of investments
4. They provide “Price discovery mechanism”

Question 37

What is price discovery mechanism?

Answer 37

You can see the prices of stocks and bonds.
It provides information to primary market. It allows primary market dealer to know how to price new bonds based on prices of bonds on the secondary markets.
It reduces risk to underwriter, which causes the spread to be tighter, and more money going to capital formation.

Question 38

How do loans show up on the balance of a bank?

Answer 38

Loans are banks assets.

This claim the bank has on xyz is a primary claim. Indirect lending.

Question 39

Why is indirect lending more risky than direct lending?

Answer 39

Before the financial crisis in 2008, the banks were creating subprime morgages into MBS and selling them to investors with high interest rate. They were no longer doing the job of checking the financial credit worthiness of the loans.