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WHEN WAS THE FINANCIAL SERVICES MODERNIZATION ACT MADE?
1999
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WHAT PROMPTED THE FINANCIAL SERVICES MODERNIZATION ACT
THE MERGER OF CITIGROUP AND TRAVELERS INS. GROUP IN 1998
- PRIOR TO THE ACT COMMERCIAL BANKS CAN ENGAGE IN ONLY LIMITED ACTIVITIES
- -NO SECURITIES AND INSURANCE COVERAGE
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BECAUSE OF THE FINANCIAL SERVICE MODERNIZATION ACT, WHAT WERE SOME OF THE IMPACTS OF THE RECENT MARKET TURMOIL ON THE CONSOLIDATING TREND?
BANKS LIMIT THE BUSINESS THEY DO
- NON BANK INSTITUTIONS CONVERT TO BANK HOLDING COMPANIES
- -I.E. GOLDMAN SACHS AND MORGAN STANLEY
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WHAT ARE THE DIFFERENT TYPES OF DEPOSIT ACCOUNTS, AND WHAT ARE THEIR CHARACTERISTICS?
- TRANSACTION DEPOSITS
- -DEMAND DEPOSIT ACCOUNT (CHECKING)
- -(TRADITIONALLY NO INTEREST)
- NEGOTIABLE ORDER OF WITHDRAWAL (NOW) ACCOUNT (1981)
- -WITH INTERESTS BUT REQUIRES A LARGER MINIMUM BALANCE
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WHAT ARE LONG TERM SOURCES OF FUNDS FOR COMMERCIAL BANKS?
BONDS ISSUED BY BANKS
- BANK CAPITAL
- -PRIMARY CAPITAL
- -(TIER I) COMMON AND PREFERRED STOCKS, RETAINED EARNINGS
- SECONDARY CAPITAL (TIER II)
- -SUBORDINATED NOTES AND BONDS
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WHAT DO BANKS NEED TO SATISFY IN ORDER TO COMPETE LONG TERM?
CERTAIN CAPITAL REQUIREMENTS IN ORDER TO ABSORB LOSSES
IN THE PAST BANK CAPITAL WAS A PERCENTAGE OF TOTAL ASSETS
SINCE 1992 BANK CAPITAL WAS A PERCENTAGE OF RISK WEIGHTED ASSETS
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WHAT WAS BANK CAPITAL BASED ON IN THE PAST?
A PERCENTAGE OF TOTAL ASSETS
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SINCE 1992 WHAT HAS BANK CAPITAL BEEN BASED ON
PERCENTAGE OF RISK WEIGHTED ACTIVITIES (LOOK AT SLIDE 16 ON CH.17)
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WHAT ARE THE FOUR TYPES OF BUSINESS LOANS?
WORKING CAPITAL LOANS(CURRENT ASSETS-CURRENT LIABILITIES=WORKING CAPITAL)
TERM LOANS- USED TO PURCHASE FIXED ASSETS, AND THEY HAVE PROTECTIVE COVENANTS
INFORMAL LINE OF CREDIT(SUSCEPTIBLE TO HAVING CREDIT LINE CUT)
REVOLVING CREDIT LOAN- WHETHER YOU BORROW OR NOT, YOU WILL BE CHARGED, (MUCH MORE SAFER) REVOLVING WOULD BE BEST SUITED FOR EMERGENCIES BECAUSE THEY ARE LIQUID.
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IVESTMENT IN SECURITIES IS COMPOSED MAINLY OF WHAT?
- PRIMARILY DEBT SECURITIES
- -TREASURY SECURITIES
- -AGENCY SECURITIES
- -CORPORATE AND MUNICIPAL SECURITIES (INVESTMENT GRADE ONLY)
- -MORTGAGE BACKED SECURITIES.
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WHAT ARE OFF BALANCE SHEET ACTIVITIES?
- ACTIVITIES THAT DO NOT AFFECT THE BALANCE SHEET RIGHT AWAY, BUT LIKELY IN THE FUTURE.
- -THEY CREATE CONTINGENT OBLIGATIONS
- -THESE ACTIVITIES NEED TO BE DISCLOSED NOWADAYS.
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WHAT IS A LOAN COMMITMENT?
- OBLIGATION OF A BANK TO PROVIDE A SPECIFIED LOAN AMOUNT TO A PARTICULAR BUSINESS UPON REQUEST.
- -NOTE ISSUANCE (NIF) FOR COMMERCIAL PAPERS
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WHAT ARE STANDBY LETTERS OF CREDIT?
BACKS A CUSTOMERS OBLIGATION TO A THIRD PARTY
BANKS EARN FEE INCOME
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WHAT ARE CURRENCY FORWARD CONTRACTS?
- Agreement between a customer and a bank to
- exchange one currency for another on a particular future date at a specified
- exchange rate
- Allows customers to hedge their
- exchange-rate risk
The bank can also serve as an intermediary
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WHAT ARE INTEREST RATE SWAP CONTRACTS?
- Two parties agree to periodically exchange interest payments on a
- specified notional amount of principal (Fixed rate for floating rate and the reverse)
- The bank can serve as an intermediary or a guarantor for a fee, or the
- counterparty in a swap contract
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WHAT ARE CREDIT DEFAULT SWAP CONTRACTS?
- Privately negotiated contracts that protect buyers against the risk of
- default on debt securities
- -(Sellers receive periodical fees income, but they will have to cover the losses on the debt
- securities for the buyers in cases of default –E.g., AIG)
IN OTHER WORDS, WHEN YOU BUY SOMETHING THAT IS RISKY, BUY INSURANCE TO PROTECT YOURSELF.
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WHAT DOES THE DUAL BANKING SYSTEM CONSIST OF?
- Federal-
- National bank
- –Chartered by the Comptroller of the Currency
- –Members of the Federal Reserve System
- State
- State bank
- -Chartered by state agencies
- –May be members of the Federal Reserve System
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COMMERCIAL BANKS CAN EITHER BE INDEPENDENTLY OWNED OR OWNED BY A _________________
- BANK HOLDING COMPANY (BHC)
- -MOST BANKS ARE OWNED BY BHC'S
- -BHC'S HAVE MORE POTENTIAL FOR PRODUCT DIVERSIFICATION THAN
- INDEPENDENTLY OWNED BANKS
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WHAT ARE THE FORMER AND AND CURRENT INSURANCE RATES FOR THE FDIC?
- USED TO BE $100,000 PER DEPOSITOR
- CURRENTLY UP TO $250,000 PER DEPOSITOR THROUGH DECEMBER 31, 2013
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WHAT ARE SOME OF THE OUTCOMES FROM THE REGULATION OF INVESTMENT IN SECURITIES?
- Banks are not allowed to use borrowed or deposited funds to purchase
- common stocks
Banks can invest only in investment-grade bonds
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WHAT IS THE GLASS-STEAGALL ACT OF 1933?
- Prevent any firm that accepts deposits from underwriting stocks and
- bonds of corporations
- Separated banking and securities activities
- –To prevent potential conflicts of interest
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what are the implications from the financial services moderniazation act of 1999?
Essentially repealed the Glass-Steagall Act
- Easier for commercial banks to engage in securities and insurance
- activities
- –Increase the degree to which banks can
- offer securities services
- –Allow securities firms and insurance
- companies to acquire banks
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what is the implication of off balance sheet transactions?
- Risk-based capital requirements are higher for banks that conduct more
- off-balance sheet activities
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what can you tell me about the regulation of the accounting process?
- SARBANES OXLEY ACT OF 2002
- Make corporate managers, board members, and auditors of public firms
- more accountable for the accuracy of the financial statement that their
- respective firms provided.
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WHY DO BANKS NEED SUFFICIENT CAPITAL?
TO ABSORB POTENTIAL OPERATING LOSSES
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WHY WOULD BANKS PREFER LOW CAPITAL
TO BOOST ROE
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WHAT IS THE NAME OF THE SYSTEM USED TO MONITOR BANKS?
THE CAMELS SYSTEM.
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WHAT DOES C IN CAMELS STAND FOR, AND WHAT DOES IT MEAN?
- Capital adequacy
- -Regulators determine the capital ratio (capital divided by assets) of
- a bank
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WHAT DOES A IN CAMELS STAND FOR AND WHAT DOES IT MEAN?
Asset quality
- The FDIC evaluates the quality of a bank’s assets, including its loans and
- securities
Capacity Capital
Collateral Character
Condition
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WHAT DOES M IN CAMELS STAND FOR AND WHAT DOES IT MEAN?
Management
- The FDIC specifically rates the bank’s management according to administrative skills, ability to comply with existing regulations, and ability to cope with a changing environment
- -Also assesses the bank’s internal control systems
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WHAT DOES E IN CAMELS STAND FOR AND WHAT DOES IT MEAN?
Earnings
- A commonly used profitability ratio to
- evaluate banks is return on assets (ROA), defined as earnings after taxes
- divided by assets
- -Earnings can also be compared to industry earnings
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WHAT DOES L IN CAMLES STAND FOR AND WHAT DOES IT MEAN?
Liquidity
- Regulators prefer that banks do not consistently rely on outside
- sources of funds such as the discount window
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WHAT DOES S IN CAMELS STAND FOR AND WHAT DOES IT MEAN?
Sensitivity
- The degree to which a bank might be exposed to adverse financial market conditions
- -Much emphasis on a bank’s sensitivity to interest rate movements
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WHAT IS THE OVERALL GOAL OF BANK MANAGEMENT?
- Goal: Maximize shareholder wealth
- -Managerial decisions may conflict with this goal
- -Agency problems
- –The problem that an agent may not behave in the best interests of a principal
- Agency costs
- –The costs associated with the existence, prevention, and correction of agency problems
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WHAT IS INTEREST RATE RISK? HOW DO YOU MEASURE IT? AND WHAT ARE THE IMPLICATIONS?
The profitability a bank is highly influenced by interest rate changes
Net interest margin
(Interest revenues – interest expenses)/Assets
REMEMBER NET INTEREST MARGIN IS A PROFITABILITY MEASURE, SO YOU WANT IT TO BE HIGHER!!!! THE HIGHER THE BETTER!!!!!
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WHAT IS THE GAP ANALYSIS? AND WHAT IS THE IMPLICATION?
RATE SENSITIVE ASSETS-RATE SENSITIVE LIABILITIES
- RATE SENSITIVE DEFINITION- The applicable interest rate is adjusted frequently (as the market
- interest rate changes)
IMPLICATION- NEGATIVE FOR MOST BANKS REMEMBER BANKS LIKE LOW INTEREST RATES..... SO WHEN I RATE GOES DOWN, ASSETS GET PAID BUT THEY WILL EVENTUALLY LOWER AND DEPOSITS WILL LOWER. THIS IS A BENEFIT.
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WHAT IS DURATION ANALYSIS? AND WHAT IS THE IMPLICATION?
- Duration
- -A measure of how sensitive the value of assets (or liabilities) is to interest rate changes
- -A higher duration means a higher sensitivity
IMPLICATION- FOR MOST BANKS THIS NUMBER IS POSITIVE.
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WHAT IS REGRESSION ANALYSIS? AND WHAT IS THE IMPLICATION?
Analysis of how a bank’s performance is affected by interest rate changes
- IMPLICATION- USUALLY NEGATIVE
- REMEMBER, IF I RATE IS HIGH, THEN BANK STOCKS GO DOWN HIGH INTERESTS RATES HURTS BANKS
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IN TERMS OF GAP, DURATION AND REGRESSION WHAT ARE THE NEGATIVE/POSITIVE IMPLICATIONS FOR EACH RESPECTIVELY?
BANKS USUALLY HAVE
- NEGATIVE GAP
- POSITIVE DURATION GAP
- NEGATIVE B2 IN THE REGRESSION ANALYSIS
RISING INTERESTS RATES HURT BANK PERFORMANCE
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HOW DO BANKS REDUCE INTEREST RATE RISK?
MATURITY MATCHING-(ASSET SIDE AND LIABILITY SIDE MOVE IN SAME DIRECTION)
USING FLOATING RATE LOANS(BANKS LIKE TO USE THIS WHEN THEY EXPECT INTEREST RATES TO INCREASE)
- USING INTEREST RATE FUTURES(BOTH FUTURES AND SWAPS ALLOW YOU TO LOCK IN 1 RATE)
- USING INTEREST RATE SWAPS
USING INTEREST RATE CAPS( IF YOU HAVE A LOAN, YOU CAN SET UP A CAP TO HOW HIGH THE INTEREST RATE CAN BE)
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WHAT IS CREDIT RISK?
The risk that a debtor may not be able to repay the credit
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Should a bank try to minimize its credit risk exposure?
NO!!!!!! BANKS NEED TO KNOW THE LEVEL AT WHICH THEY CAN BEAR RISK
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WHAT IS RISK RETURN TRADEOFF?
TAKE A RISK TO THE AMOUNT YOU CAN TOLERATE
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WHAT IS THE TRADEOFF BETWEEN RISK AND RETURN?
A BANK CANNOT SIMULTAANEOUSLY MAXIMIZE RETURN AND MINIMIZE CREDIT RISK
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WHAT DOES A BANK DO SINCE IT CANNOT SIMULATNEOUSLY MAXIMIZE RETURN AND MINIMIZE CREDIT RISK?
THE BANK ATTEMPTS TO EARN A REASONABLE RETURN AND MAINTAIN CREDIT RISK AT A TOLERABLE LEVEL.(DEPENDS ON INDIVIDUAL BANKS SITUATION)
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WHAT IS MARKET RISK?
- The risk that the value of securities may change due to changes in
- financial market conditions
- -As banks pursue new services related to the trading/holding of securities, their exposure to market risk increases
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HOW DO YOU MEASURE MARKET RISK?
THE VALUE AT RISK APPROACH-(VaR)- THE MAXIMUM POSSIBLE LOSS GIVEN A PROBABILITY OR SCENARIO
REMEMBER!!!! A BANKS MARKET RISK ALSO DEPENDS ON ITS INTEREST RATE RISK EXPOSURE. MOST BANKS ASSESS IONTEREST RATE RISK OVER A RELATIVELY LONG TIME, BUT MARKET RISK ON A SHORTER TERM HORIZON
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WHAT IS FINANCIAL LEVERAGE?
THE EXTENT TO WHICH LIABILITIES ARE USED TO FINANCE ASSETS
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DO BANKS HAVE HIGHER OR LOWER FINANCIAL LEVERAGE?
HIGHER
-MAJORITY OF BANK ASSETS GENERATE PREDICTABLE CASH FLOWS
- -BANKS MUST MEET THEIR MINIMUM CAPITAL REQUIREMENTS
- -THE REQUIREMENT FOR A BANK DEPENDS ON ITS RISK
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WHAT DOES EXCESSIVE CAPITAL DO FOR THE PROFITABILITY OF SHAREHLDERS?
IT REDUCES THEIR PROFITABILITY
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HOW DO YOU FIND ROE?
ROE=ROA * EQUITY MULTIPLIER
- EQUITY MULTIPLIER= ASSETS/EQUITY
- ROA= NET INCOME/ASSETS
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WHAT IS THE TRADEOFF FOR A HIGHER LEVEL OF CAPITAL?
- BETTER ABILITY TO ABSORB LOSSES
- LOWER RETURN FOR SHAREHOLDERS
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HOW DO BANKS INCREASE CAPITAL?
- ABSOLUTELY INCREASE CAPITAL:
- KEEP RETAINED EARNINGS
- ISSUE NEW STOCKS
- RELATIVELY:
- SELL LOANS
- REDUCE ANY OTHER RISKY ACTIVITIES
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WHAT IS A THRIFT/SAVINGS INSTITUTION?
Depository institutions specializing in mortgage lending
- -Savings bank
- –Insured by Bank Insurance Fund (BIF)
- -Savings and loan associations (S&Ls)
- –Insured by Savings Association Insurance Fund (SAIF)
–BIF and SAIF are both administrated by FDIC
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WHAT ARE CHARACTERISTICS OF THRIFT OPERATIONS?
S&Ls are the most common
SIs are usually small in terms of their assets
- Savings banks are concentrated in
- northeastern U.S.
S&Ls are spread across the country
SIs are either stock owned or mutual
Most are stock owned
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WHAT ARE USES OF FUNDS FOR THRIFT OPERATIONS?
- CASH
- MORTGAGES
- -PRIMARY USE
- MORTGAGE BACKED SECURITIES
- OTHER SECURITIES
- TREASURY SECURITIES
- CORPORATE BONDS
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WHAT ARE THE RISKS FOR THRIFT OPERATIONS IN TERMS OF LIQUIDITY, CREDIT AND INTEREST RATE?
- Liquidity risk
- Relatively high
- Credit risk
- Relatively low
- Interest rate risk
- Relatively high
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WHAT IS A CREDIT UNION?
- Nonprofit,
- mutual organizations owned by depositors (members) with common bonds
- Same university, community, church, ...
Deposits are called shares, and the interest paid is called dividends
CU income is not taxed
Either federally or state chartered
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WHAT ARE ADVANTAGES OF CREDIT UNIONS?
CUs are not taxed
Affiliation-supported facilities
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WHAT ARE DISADVANTAGES OF CREDIT UNIONS?
Employees may lack incentives
Limited size and diversification
Unable to get funds by issuing stocks
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IF CU'S NEED FUNDS TEMPORARILY WHERE CAN THEY GO?
- If CUs need funds temporarily, they can borrow from other credit unions or from the
- Central Liquidity Facility (CLF)
CLF acts as a lender for CUs much like the Fed’s discount window for banks
- CLF is part of a larger system called the Corporate Credit Union Network
- -Credit union for credit unions
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WHO REGULATES AND SUPERVISES CREDIT UNIONS?
NCUA (NATIONAL CREDIT UNION ASSOCIATION)
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WHAT ARE THE CAPITAL REQUIREMENTS OF CREDIT UNIONS?
CAPITAL RATION OF 8% OF RISK WEIGHTED ASSETS
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WHO REGULATES CU DEPOSIT INSURANCE?
- Deposits are insured by the National Credit Union Share Insurance Fund
- (NCUSIF, since 1970)
- ADMINISTERED BY NCUA
- 90 percent of CUs are insured by NCUSIF (all Federal CU are insured)
- Used to be up to $100,000 per depositor
- Currently up to $250,000 per depositor through December 31, 2013
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WHAT IS THE EXPOSURE TO LIQUIDITY RISK FOR CU'S?
- Localized depositors
- -Can have unanticipated surges of withdrawals
Relatively high
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WHAT IS THE EXPOSURE TO CREDIT RISK FOR CU'S?
- Concentrate on personal loans to members, Many of whom may be employed by same
- employer
Relatively high
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WHAT IS THE EXPOSURE TO INTEREST RATE RISK FOR CU'S?
- More insulated from interest rate risk than banks
- -Assets (consumer loans) maturities are typically short term, matching the short-term liabilities
- -The spread between interest revenues and interest expenses has been relatively stable
Relatively low
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WHAT IS A CREDIT UNION SERVICE CENTER?
- Shared facility (shared branching) by participating CUs (since 1992)
- -Allow members to make deposits and withdrawals as if it were their own credit union branch
- As of April 2010
- -Most CUs participate
- -4034 service center locations
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WHAT ARE FINANCE COMPANIES?
THEY PROVIDE SHORT AND INTERMEDIATE TERM CREDIT TO CONSUMERS AND SMALL BUSINESSES.
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WHAT ARE CONSUMER FINANCE COMPANIES?
- –Provide financing for customers of retail
- stores or wholesalers
Provide direct loans to individuals
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WHAT ARE BUSINESS FINANCE COMPANIES?
–Offer loans to small businesses
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WHAT ARE CAPTIVE FINANCE SUBSIDIARIES?
Wholly owned subsidiary with the primary purpose to finance sales of the parent company’s products and services
Provide financing to distributors/consumers of the parent company’s products
Purchase receivables of the parent company
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WHAT ARE ADVANTAGES OF CFS?
Corporations can separate manufacturing and retailing from financing
Easier and less expensive to analyze each segment of the parent firm
- Captive establishes credit rating separate from the parent firm
- –Can get funding on its own
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HOW DO CFS COMPARE WITH OTHER FINANCIAL INSTITUTIONS?
No reserve requirement
No restrictions on how to obtain funds
Competitive advantage in retail sales
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WHAT IS COMMERCIAL PAPER?
- A short-term money market source but finance companies can roll over
- their issues to create a permanent source of funds (INTEREST RATE RISK)
- Secured commercial paper allows smaller and medium-sized finance
- companies access to the market
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WHAT IS AN EASY TO SECURE A PERSONAL LOAN AND WOULD YOU DO IT?
USUALLY DONE BY A COSIGNER OR BY REAL PROPERTY, NO DONT CO SIGN.
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WHO PROVIDES THOSE 90 DAY SAME AS CASH LOANS THAT YOU SEE AT FURNITURE STORES?
FINANCIAL INSTITUTIONS
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WHAT IS CASH CYCLE?
THE TIME BETWEEN CASH DISBURSEMENT AND CASH COLLECTION. OFTEN BACKED BY ACCOUNTS OR INVENTORY.
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WHAT IS A BUSINESS LOAN?
LOANS TI FINANCE THE CASH CYCLE OF COMPANIES
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WHAT IS A LEVERAGED BUYOUT LOAN?
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WHAT IS THE LIQUIDITY RISK FOR FINANCE COMPANIES?
- Finance companies do not hold assets that can be easily sold
- -May securitize loans
- Balance sheet structure does not call for much liquidity because of
- little deposit outflow
Relatively low
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WHAT IS INTEREST RATE RISK FOR FINANCE COMPANIES?
Maturities of assets and liabilities typically do not differ much
- Assets are typically not as sensitive as liabilities to interest rates
- -Can use adjustable rates and shorter maturities on their loans
Relatively low
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WHAT IS THE CREDIT RISK FOR FINANCE COMPANIES?
The major risk faced by finance companies
Loan delinquency rates are typically higher than those of other lending institutions
High-risk, high-return nature of loans makes performance sensitive to prevailing economic conditions
Relatively high
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WHAT FINANCING SERVICES DOES GMAC PROVIDE?
- Automotive loans
- Banking (Ally Bank)
- Investing
- Insurance
- Mortgages
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WHAT IS THE HISTORY OF PAYPAL?
- FOUNDED IN 1998
- BOUGHT BY EBAY IN 2002
- MAJOR SERVICES:
- ONLINE PAYMENT
- BUYER CREDIT/BILL ME LATER(DONE BY FINANCE COMPANIES)
- MONEY MARKET FUND
- DEBIT CARDS
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WHAT IS A MUTUAL FUND AND WHAT ARE THE BENEFITS?
A pool of investments managed by professional managers
- Benefits
- -Administration and record keeping
- -Diversification and divisibility
- -Professional management
- -Reduced transaction costs
-Very popular since 90s
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WHAT ARE OPEN ENDED FUNDS?
Not listed
Transactions with the fund
- Number of shares outstanding changes when
- new shares are sold or old shares are redeemed
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WHAT ARE CLOSE ENDED FUNDS?
Listed on exchanges
Transactions with other investors
Fixed number of shares outstanding
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WHAT IS NET ASSET VALUE AND WHAT ARE THE IMPLICATIONS FOR OPEN AND CLOSED ENDED FUNDS?
The value (not necessarily price) of each share in a fund
MARKET VALUE OF ASSETS-LIABILITIES/NUMBER OF SHARES OUTSTANDING
For open-end funds, NAV is the price that investors will buy (sell) shares from(to) the fund
For closed-end funds, share prices are frequently lower than their NAVs The mysterious “closed-end fund discount”
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IN INVESTING, WHAT DOES LOAD MEAN?
IN ORDER TO BUY, PAY ME FIRST
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WHAT IS FRONT END AND A BACK END LOAD?
FRONT END = BUY
BACK END = SELL
(BOTH ARE ONE TIME CHARGES)
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IF YOU DONT GET CHARGED FRONT END OR BACK END LOADS WHAT WILL YOU GET CHARGED?
ANNUAL 12B-1 CHARGE
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WHAT ARE THE STOCK MUTUAL FUNDS INVESTMENT STYLES?
Capital appreciation (aggressive growth)-HIGH RISK
- Growth
- Growth and income (BOTH OF THESE ARE SAFE)
Specialty- BASED ON INDUSTRY
INDEX- DJIA, S&P ETC.
INTERNATIONAL AND GLOBAL
- MULTIFUND (FUNDS ON FUNDS) AVOID!!!!!
- WHY IS THIS BAD? OVERPAYMENT
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WHAT ARE ASSET ALLOCATION FUNDS?
Invest in stocks, bonds, and money market securities
- The actual composition of a fund is adjusted over time to reflect the
- portfolio manager’s expectation on the market situation
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WHAT IS AN EXCHANGE TRADED FUND?
Track indexes, Listed on exchanges, Becomes very popular in recent years, Have the characteristics of both open-end funds and closed-end funds
- Similar to indexed mutual funds
- Share price reflects changes in an index
- Pay dividends earned in additional shares
- Low management fees
- Similar to closed-end funds
- Listed with continuous price during the trading hours
- Transaction costs (broker fees) MARKET ORDER
Have tax advantages over indexed mutual funds, Unlike closed-end funds, share prices of ETFs do not deviate from their net asset value too much
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WHAT IS A REAL ESTATE INVESTMENT TRUST (REIT)
- A closed-end fund that invests in real estate or mortgages
- Equity REIT
- -Invest in properties
- -Can be used to hedge against inflation
- Mortgage REIT
- -Invest in mortgages and construction loans
- (AVOID WHEN INFLATION IS HIGH!!!!)
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WHAT IS A UNIT INVESTMENT TRUST?
- An investment company that offers a fixed (unmanaged) portfolio of securities as
- redeemable "units" to investors for a specific period of time
- -Assembled by a sponsor, e.g., a bank.
- -Sold through brokers to investors
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WHAT IS A VENTURE CAPITAL FUND?
- Pool of money from wealthy individuals and institutional investors invested in young, growing, and typically privately-held firms
- -Usually in the form of limited partnership
- -Exits through IPOs or sales of the firms
- -High risk and high return
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WHAT IS A PRIVATE EQUITY FUND?
- Pool of money from wealthy individuals and institutional investors aiming at acquiring majority stakes in businesses
- -Usually in the form of limited partnership
- -Profit from improved business performance
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WHAT IS A HEDGE FUND?
- Unregulated, not allowed to advertise
- -Target wealthy individuals and institutions
- Usually in the form of limited partnership
- High risk and high return
- -Use strategies to magnify returns on investment
- Investment strategies
- -Along with equity investments
- -Long/short derivative securities
- -Sell stocks short
- -Use borrowed funds
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WHAT HAVE RESEARCHERS FOUND OUT ABOUT MUTUAL FUND PERFORMANCE OVER TIME?
- Researchers have found that, on average, mutual funds did not outperform the market
- -Raise questions on the ability of fund managers
- -Mutual funds may still fit investors’ needs by providing diversification and other services
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WHAT ARE SOME INVESTMENT BANKING FIRMS?
- Goldman Sachs, Morgan Stanley
- -They are now bank holding companies
- -Some well-known ones including Bear Stearns, Lehman Brothers, and Merrill Lynch, were either bankrupted or acquired
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WHAT ARE THE FUNCTIONS OF AN IBF? (INVESTMENT BANKING FIRM)
Functions of IBFs
- Originating
- Registration statement
- Prospectus
- Underwriting
- Distribution
- Advising
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WHAT IS A SYNDICATE?
A GROUP OF UNDERWRITERS
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WHAT IS FIRM COMMITMENT?
UNDERWRITER BEARS RISK
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WHAT IS BEST EFFORTS?
ISSUER BEARS RISK
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TRUE OR FALSE IBF'S CAN ISSUE STOCKS AS WELL AS BONDS
TRUE
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TRUE OR FALSE THE FEES FOR BOND ISSUANCE ARE LOWER THAN THOSE FOR STOCK ISSUANCE?
TRUE
- WHY?
- EASIER TO DISTRIBUTE
- LESS PRICE UNCERTAINTY
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WHAT IS PRIVATE DIRECT INSURANCE
- An issuer can also choose to place its bonds by itself
- -Usually smaller issues targeting a few institutional investors
- –Insurance companies, commercial banks, etc.
- -Flexible (negotiable) terms on the issues
- -To avoid the underwriting fees
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WHAT IS A LEVERAGED BUYOUT? (BORROW ALOT TO BUY A COMPANY)
- The acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition
- -The assets of the company being acquired are usually used as collateral for the loans, in addition to the assets of the acquiring company
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WHAT ARE ARBITRAGE ACTIVITIES? (BUY CHEAPER ONES, SELL MORE EXPENSIVE ONES)
Activities of purchasing undervalued assets and reselling them at higher prices
- -Asset stripping
- –A firm is acquired and then its individual divisions are sold off by the arbitrager
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WHAT IS A MERGER?
A merger usually involves two firms of similar sizes, resulting in a new larger firm
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WHAT IS AN ACQUISITION?
An acquisition usually has one large acquiring firm and one small target firm. After the acquisition only the large acquiring firm is left
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WHAT ARE THE ARBITRAGE ACTIVITY CONSTRAINTS?
- Uncertainty in asset prices
- Sources of financing
- Transaction costs
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WHAT IS A FULL SERVICE BROKER?
- Traditional
- Executes transactions and provides information and advice
- -E.g., Merrill Lynch of Bank of America
- HIGHER TRANSACTIONS COSTS THAN DISCOUNT BROKER!
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WHAT IS A DISCOUNT BROKER?
- Executes transactions only
- Compete in price (broker commission)
- Becomes more popular
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WHO PERFORMS THE DAY TO DAY REGULATION ON THE SECURITY INDUSTYRY?
FINRA (FINANCIAL INDUSTRY REGULATORY AUTHORITY)
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WHAT DOES THE SECURITIES INVESTOR PROTECTION CORPORATION DO?
- Provides insurance on cash and securities deposited at brokerage firms
- -$500,000 total, including $100,000 against cash
- -SEC-registered brokers are insured
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WHAT ARE THE MARKET RISK, INTEREST RATE RISK, CREDIT RATE RISK, AND EXCHANGE RATE RISK FOR SECURITIES OPERATIONS?
- MARKET RISK BASED ON MARKET CONDITIONS
- INTEREST RATE RISK BASED ON INTEREST RATE CHANGES
- CREDIT RISK BASED ON CUSTOMER CREDIT
- EXCHANGE RATE RISK- THIS BECOMES MORE IMPORTANT AS COMPANIES MOVE TOWARDS GLOBALIZATION.
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WHAT IS AN AGENCY PROBLEM?
THE PROBLEM THAT AN AGENT MAY NOT BEHAVE IN THE BEST INTERESTS OF A PRINCIPAL.
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WHAT ARE AGENCY COSTS?
THE COSTS ASSOCIATED WITH THE ESISTENCE, PREVENTION, AND CORRECTION OF AGENCY PROBLEMS
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