Quiz 2 Flashcards
Investment banking definition
refers to activities related to underwriting and distributing new issues of debt and equitiy securities
Two different types of IB offerings
Public offerings and Private offerings
What are public offerings
represent the sale of a security to the public at large. Securities may be underwritten on a best efforts or a firm commitment basis
what are private offerings
an investment bank acts as a private placement agent for a fee, placing the securities with one or a few large institutional investors
other way IB may participate
may participate as an underwriter in government, municipal, and morgaged-backed securities
Why does VC exist
difficult for new and small firms to obtain debt financing from CBs because CBs not generally willing to make loans to new companies with no assets or business history
Venture capital definition
professionally managed pool of money used to finance new and often high risk firms
what do VC get to invest in untried companies and managers
equity investment in firm
what type of investors are VC investors
not generally passive investors, provide valuable expertise to firm’s managers and may help with recruiting
two different types of vc firms
institutional vc and angels
what are institutional vc firms
business entities whose sole purpose is to find and fund the most promising new firms
what are angel investors
weathly individuals who make equity investments
what is trading similar to
market making
what does a trader do
take an active net position in an underlying instrument or asset
what are the 6 different types of trading activities
position trading, pure arbitrage, risk arbitrage, program trading, stock brokerage, electronic brokerage
what is position trading
involves purchases of large blocks of securities on the expectation of a favorable price move
what is pure arbitrage trading
involves buying an asset in one market at one price and selling it immediately in another market at a higher price
what is risk arbitrage trading
involves buying securities in anticipation of some information release
what is program trading
simultaneous buying and selling of a portfolio of at least 15 different stocks valued at more than $1 million using computer programs to initiate such trades
what is stock brokerage trading
involves trading securities on behalf of customers
what is electronic brokerage trading
involves direct digital assets, via internet, to the trading floor, therefore bypassing traditional brokers
what is the securities investor protection corporation (SIPC)
it protects investors against losses of up to $500,000 on securities firm failures
is the SIPC an agency or establishment
no, not an agency nor establishment of US government, has no authority to investigate or regulate its member broker dealers
when was SIPC created
under the Securities Investor Protection Act of 1970 as a non-profit membership corporation
what does the SIPC do
oversees the liquidation of member broker-dealers that close when the broker-dealer is bankrupt or in financial trouble and customer assets are missing
focus on restoring customer cash and securities left in hands of bankrupt of otherwise financially troubled brokerage firms
what do life insurance companies do
they accept or underwrite risk that a perscribed event will occur for insurance premiums
what is underwriting
a major part of life insurance companies, the process in determining which risks should be accepted and which should be rejected
and then for accepted risks, underwriters must determine how much to charge (in form of premiums)
adverse selection problem
exists because customers who apply for insurance policies are more likely to be those more in need of coverage
Assets of life insurers
concentrate asset investments at the longer end of maturity spectrum (corportate bonds, equities, government securities)
liabilities of life insurers
net policy reserves (76.9% of total liabilities)
to meet unexpected future losses, life insurers hold a capital and surplus reserve fund with which to meet such losses
what is loss risk
measures actual losses incurred on a specific policy line
calculated as ratio of losses incurred to premiums earned
what is expense ratio
calculated as expenses incurred (before federal income tax) divided by premiums written
key feature of loss risk
the actuarial predictability of losses relative to premiums earned, which are premiums received and earned on insurance contracts because time has passed without a claim being filed
what is generally true of loss risk
- max levels of losses more predictable for property lines than for liabilty lines
- loss rate more predictable on low severity, high frequency than on high severity low frequency lines
- long tail risk exposure makes estimation of expected losses difficult
- loss rates on all P&C property policies are adversly affected by unexpected increases in inflation, while liability lines may be subjected to social inflation as reflected by juries willingness to award punative and other damages at rates far above underlying rate of inflation
what is an alternative risk to managing risk on a P&C insurer’s balance sheet
reinsurance, ie insurance for insurance companies
what is a combined ratio
measure of overall profitability of a line
how is comibed ratio calculated
loss ratio plus ratio of loss adjusted expenses to premium earned as well as commission and other costs to premiums written plus any dividends paid to holders
what is investment yield
net investment income divided by premiums earned
what is operating ratio
measure of overall profitability
calculated as the combined ratio minus the investment yield
number of mutal funds over time
equity funds fast growth, 85-2007, about stable since 07 most out of any
fast growth overall until 07 then decrease in 10 and stable since
what does a money market mutal fund do
provides an alternative investment opportunity to interest-bearing deposits at commerical banks
who owns majority of both long and short term mutal funds
house holds
three aspects of investors returns in a MF
- portfolio earns income and dividends on those assets
- capital gains occurs when MF sells for profit
- sale of additional MF shares and profitable investment made with the funds from these shares can produce a capital appreciation that adds the value of all shares in the MF
when are mutal fund assets assessed
mutal fund assets are normally market to market daily (managers of funds calculate current value of each share by computing daily market value of funds total asset portfolio less any liabilities, and then dividing by amount of outstanding shares)
what is the net asset value (NAV) of a share
equal to market value of assets in the MF portfolio divided by the number of outstanding shares
3 types of mutal fund costs
Load fund, no-load fund, 12b-1 fees, operating expenses
what are load funds (MF cost)
up front (one time) sales/ commission charge that investor must pay
what is a no-load fund
does not charge up front sales or commission charges on the sale of MF shares to investors
what are fund operating expenses (MF cost)
annual fees given to investors so that fee = operating expense, management fee is charged to meet operating costs
what are 12b-1 fees
relate to distribution of MF shares
fees that are used to pay marketing and distribution expenses, which cannot exceed 0.75% of a funds average net assets per year
advantages of fintechs to banks
fintech advantages: being unburdened by regulators, legacy IT systems, branch networks, not having need to protect existing businesses, possessing an innovation mindset, adjility, and a consumer centric perspective
advantages of banks over fintech
3 C’s: customers, compliance, capital
how is the relationship between banks and fin tech changing
most fintech CEOs expect incresing fintech-bank partnerships in future, can have mutually benefical partnerships
4 stages of fintech startups and banks
- “rent a bank”
- banks buy assets and take equity stake in fintech startups
- fintech firms provide technology and infastructure to banks
- banks develop in house fintech arms, fintech startups start apply for bank charter
what is banking as a service (BaaS)
end to end process that allows fintechs and other 3rd parties to connect with banks via APIs so they can build bank offerings on top of bank’s infastructure to reach users outside of banks existing footprint
what is open banking
a system that provides a user with a network for FI’s data using APIs.
advantage to open banking
by opening APIs to sharing, 3rd parties have easier access to financial information for existing bank customers, which allows them to build new apps and services
how are mid-market coporates characterized
sales between 5mill - 100mill per year
recognizable corporate structure
no ready access to deep and liquid capital markets
short term commerical loans
original maturity of one year or less used to finance working capital needs and other short term funding need
long term corporate loans
loans are used to finance credit needs that extend beyond 1 year like purchaing real assets, new venture start-up costs, and permanent increases in working captial
First step of loan analysis
FI require business loan applications to provide cash flow information
4 sections of statement of cash flows
CF from operating activities
CF from investing activities
CF from financing activities
Net change in cash and marketable securities shown
which CF statement is most critical to FI in evaluating loan applicant
CF from operating activities
what are the factors that impact the promised return that FI acheives on any given dollar loan (asset) amount
interest rate on loan
any loan fees
credit risk premium (m) on the loan
collateral backing the loan
other nonprice terms
3 categories of direct and indirect fees and charges relating to loan
- loan origination fee (f) charged to borrower for application processing
- compensating balance requirements (b) to be held as generally non-interest bearing demand deposits
- reserve requirement charge (RR) imposed by the fed on the banks demand deposit, including any compensating balances
what is the idea behind RAROC
rather than evaluate the actual or promised annual cash flow on a loan as a percentage of the amount lent (or ROA), the lending officer balances the loan expected income against the loans expected risk
when is a loan approved by an FI using the RAROC
approaved only if the RAROC is sufficiently high relative to a benchmark return on equity capital
loan should be made only if the risk-adujsted return on the loan adds to the FI’s equity value, as measured by the ROE required by the FI stockholders
2 reasons liquidity risk arises
- when FI liability holders such as depositors or insurance policyholders, seek to cash in their financial claims immediately
- when FI needs to fund loans immediately
what is the liability side reason liquidity risk arises
FIs liability holder seeks to cash in their financial claims immediately, FIs must meet withdraws by borrowing additional funds or liquidating assets, some assets may be liquidated only at fire sale prices
what is the asset side reason liquidity risk arises
when FIs need to fund loans immediately, loan commitment allows a customer to borrow funds from an FI on demand, and when a borrower draws on its loan commitment, the FI must fund the loan on the balance sheet immediately, FIs may meet this need by running down cash assets, selling off other liquid assets, or borrowing additonal funds
what is the net deposit drain
the amount by which cash withdraws exeed additions, a net cash outflow
2 major ways FI manage a drain on deposits
purchased liquidity management, stored liquidity management
what is purchases liquidity management
an adjustement to a deposit drain that occurs on the liability side of the balnce sheet, DI manager utilizes the markets for purchased funds which are interbank markets, for short-term loans, can be expensive, availability may be llimited should the DI incur insolvency difficulties
what is stored liquidity management
adujustment to a deposit drain that occurs on the asset side of the balance sheet, fi liquidates some of its assets, utilizing stored liquidity
what is liquidity index
measures potential losses a DI could suffer as a result of a sudden (or fire sale) disposal of assets
how does size of fire-sale asset size and fair market price affect asset portfolio
larger the differences between fire-sale asset prices and fair market prices, the less liquid the DI asset portfolio
between what numbers will liquidity index always lie
between 0 and 1
what are two regluatory standards developed by BIS for liquidity risk supervision
liquidity coverage ratio (LCR) and net stable funds ratio (NSFR)
what is the liquidity coverage ratio
ensures a DI maintains an adequate level of high quality liquid assets that can be converted into cash to meet liquidty needs for a 30 day time horizon under an “acute liquidity stress scenario” specified by supervisors
what does the net stable funds ratio do
takes a longer term look at liquidity on a DI’s balance sheet
