Fin 4319-Lecture 3

Question 1

What is asset transformer?

Answer 1

na

Question 2

What’s on the balance sheet of financial intermediary?

Answer 2

Assets have primary claims

Liabilities have secondary claims

Question 3

What are life insurance policies on the balance sheet?

Answer 3

Life insurance policies are liabilities, assets are stocks and bonds. When insurance companies take the customer money they would invest in bonds until they need to pay the customer’s death.

Question 4

What about mutual funds?

Answer 4

Liabilities Fund shares are direct claims on a portfolio. Assets include stocks and bonds. Issue financial claims to purchase other financial claims.

Question 5

If you open a brokerage fund and buy stocks, is that direct or indirect?

Answer 5

Direct. Those are your claims on the security

Question 6

What if you take your money and buy a mutual fund form broker?

Answer 6

Indirect. You have a financial claim on a fund which invests in stocks/bonds.

Question 7

What are the services provided Financial Intermediaries?

Answer 7

1. Denomination divisibility. Some assets have a huge minimum ($100k or 5 million, etc.), and the FI will allow you to invest in smaller amounts of money. They pool a bunch of savers to make large loans/investments.

Question 8

What is liquidity intermediation (risk)?

Answer 8

If everyone took their money out of the bank at the same time, the bank doesn’t have the money, it’s been loaned out to DSU.

Question 9

What is maturity intermediation (risk)?

Answer 9

If interest rates go up, and the bank loan interest rates are above the savings interest rate, it’s risky.

Question 10

What are economies of scale of information?

Answer 10

FI have more information than SSU’s. It’s not cost effective for every SSU to research and know about financial markets to loan money to DSU’s.

Question 11

What are economies of scale of transaction costs?

Answer 11

A long time ago transaction costs to trade used to be high, but they aren’t anymore. Back then it used to cost a lot to trade and it was more cost effective to have brokers buy mutual funds.

Question 12

What advantages do individual investors have over institutional investors?

Answer 12

Individuals have to pay commission, bid-ask spread to dealer but they don’t have to pay price concessions. Institutions trade in huge quantities so they move the price so they have to trade slowly.

Question 13

What services do Mutual funds provide?

Answer 13

mutual funds provide Diversification of stocks and bonds

mutual funds provide Record keeping of transactions so you don’t have do taxes for the trades.

Question 14

What services do get from insurance provide?

Answer 14

Risk management. Insurance protects you from untimely death or sickness, if you die too early, your family may be in trouble.

Question 15

What is disintermediation?

Answer 15

When people stop using financial intermediaries and do direct lending. Interest rates used to be high in the 1980’s like 15% so CD’s were very popular, but since interest rates are so low now they are no longer being used.

Question 16

What is information float?

Answer 16

The time it takes for information to travel around the world. Information float is very fast now.

Question 17

What is the money market as opposed to capital markets?

Answer 17

Money market is short term financing. It’s also low risk.

Question 18

What is capital for finance?

Answer 18

Corporate stock, treasury bonds.

Question 19

What is money market?

Answer 19

It’s the market for the most liquid financial assets. It has to be cash equivalents.

Question 20

What is liquidity?

Answer 20

Liquidity - ability to convert to cash quickly at a minimal risk loss.

Question 21

What is the hierarchy of claims for bankruptcy?

Answer 21

1. Current creditors (commercial paper, taxes, wages, bank loans) (bankruptcy lawyers)
2. Bond Holders (Senior debt, junior debt)
3. Preferred stockholders
4. Common stockholders (residual claimant or owner)

Question 22

What usually happens in bankruptcy?

Answer 22

Usually bankruptcy results in reorganization instead of liquidation.
The junior debtors get common stock in the reorganized company.

Question 23

What are characteristics of cash equivalents?

Answer 23

1. the issuer has minimal default risk
2. minimal trading costs
3. minimal price risk (maturity < 1 year)

Question 24

What are in capital markets?

Answer 24

1. Bonds 
US Treasuries, Notes
Corp Bonds
Municipal bonds
2. Equities
Preferred Stock
Common Stock
3. Hybrids
Convertible bond
Convertible preferred stock
4. Mortgages

Question 25

What is working capital?

Answer 25

Short term financing

Question 26

What are Asset backed securities?

Answer 26

a

Question 27

What are mortgage backed securities?

Answer 27

Take a pool of mortgages and sell shares of them

Insurance companies and other FI’s would invest in these MBS. It’s paper so it’s easily traded.

Question 28

What are the derivatives of MBS?

Answer 28

Collaterized mortgage obligation.

Question 29

What is securitization?

Answer 29

It’s a big trend.

Question 30

What are derivatives?

Answer 30

Futures
Options
CMO

Question 31

What is the flow of savings for individuals?

Answer 31

Savings = Real Asset + Financial Asset - Financial Liability

Question 32

What is the most important investment?

Answer 32

Human Capital

The house and car are consumption

Question 33

What is the flow of savings for entire economy (aggregate)?

Answer 33

see notes