Appunti esame Financial Institutions

MONEY MARKETS- Solve cash-timing problems

Securities in the market are short term with high liquidity and low default risk, mature in 1 year or less.

Important because when a bank interest rate rose, depositors move their money to the money market.

Purpose:

• Investors: warehousing surplus fund for short periods
• Borrowers: low-cost source of temporary funds
• Corporation and US government: use this because timing of cash inflows and outflows not synchronized

Who participate in the market?

Instruments:

• Treasury bills: 28 days maturity, discounting concept, the treasury accept competitive and noncompetitive bids and the price paid is the highest paid to any accepted bid.
• Federal funds: short-term funds transferred between financial institutions for a period of 1 day - they allow to meet short-term needs with reserve requirements.
• Repurchase agreements: a firm sell Treasury securities but agree to buy them back at a certain date for a certain price.
• Negotiable certificates of deposit: a

Bank-issued security that documents a deposit and specifies the interest rate and the maturity date.

Commercial paper: unsecured promissory notes that mature in no more than 270 days.

Banker's acceptance: an order to pay a specific amount on a date if conditions are satisfied. Used usually when buyer and seller live in different countries to avoid the credit-worthiness of a customer living abroad. There is an active secondary market until they mature.

Eurodollars: dollar-denominated deposits held in foreign banks. Depositors receive a higher rate of return on a dollar deposit in the Eurodollar market than in the domestic market.

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Bonds have maturities that exceed 1 year and are used for long-term financing or investments. They are securities that represent debt owned by the issuer to the investor and have specific payments on specific dates.

Types of bonds:

• Treasury notes and bonds: Bill -> less than 1 year, Note -> 1 to 10 years, Bond -> 10 to 30 years. No default risk, very low

interest rateso Treasury inflation-indexed securities: principal amount tied too current rate of inflation

Treasury STRIPS: coupon and payments divided from t-bond, soldo as individual zero-coupon bonds

Agency debt: debt has an implicit guarantee that us governmento will not let the debt default

Municipal bonds:- used to finance public interest projects, calculate taxfree municipal interest rate

Corporate bonds:- pay interest semi-annually, cannot be redeemedanytime the issuer wishes (unless they have a call option), the degree ofrisk varies with each bond. They are registered bonds, restrictivecovenants, call provisions, conversion, secured bonds, unsecured bonds,junk bonds.

Some debt issuers use financial guarantees to lower the risk of their debt, theyare backed by large insurance companies.

Bond traders not available to the public, so trading less transparent.

Bond yields quoted using a variety of conventions, depending on the type ofissue and the market,

Bond pricing is equal to cash

flows pricing: once cash flow identified, they should be discounted to time zero at an appropriate discount rate.

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Investing in stocks: they represent ownership in a firm; you earn a return in two ways (price rises and dividend), right to vote for directors (common stock and preferred stock).

How are stocks sold?

• Organized exchanges: imply a specific trading location; small firms excluded
• Over-the-counter markets: NASDAQ, there work the dealers, market used for securities that don't trade very often. ATS and MTF allow buyers and sellers of securities to deal directly with each other. ECN allow brokers and traders to trade without the need of the middleman. All of them provide transparency, cost reduction, faster execution, after-hours trading.

ETF help keep transaction costs down offering diversification, represent a basket of securities whose content is known so valuation is certain, and management fees are low.

Compute the price of common stock: sometimes they have problems-

one-period valuation model: - The generalized dividend valuation model

Prices are set in competitive markets as the price set by the buyer willing to pay the most for an item.

Stock market indexes = used to monitor the behavior of a group of stocks (s&p500, NASDAQ composite).

SEC = protect investors and maintain the integrity of the securities markets.

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INSURANCE COMPANIES = they assume the risk of their clients (risk adverse) in return of a fee (premium).

Insurance is the contract by which the insurer, against payment of a premium, promises to compensate the insured, within the agreed limits, for the damage caused to it by a claim, or to pay a capital sum or an annuity on the happening of an event relating to human life.

To manage pure risks:

• Internal way: the individual savings
• External way: the individual organizes with each other to collectively manage the pure risk.

External management NOT DELEGATED: the individual with others who suffer the same consequences from the same pure

Risk, mutualizes its effect in the group: he pays the part of the loss that on average the group in which he participates suffers.

External management DELEGATED: the individual mandates to the insurance companies to pay for him any contractually agreed losses.

Insurance contract Organization: stock company (shareholders with profit) or mutual insurance (policyholders and lowest cost insurance).

Insurance companies as:

• Financial intermediaries: assume pure and demographic risk of the insured through contract of the same nature and against payment of a premium. They carry out a process of financial intermediation: they interpose themselves between the final exchangers. They offer negotiated solutions to meet investment and security needs of surplus unit and the borrowers.
• Institutional investors: collect company revenues in advance (inversion of business production cycle). The sum invested are the company's debt towards the insured mass (technical reserve).

Insurance business: Quantifies

Premiums are determined based on the probability of occurrence of events protected by the policy and the amount of final benefits. The cost is put in reserve and invested in assets.

Insurance operations can be divided into:

• Technical insurance management: This involves the strategic choice of company specialization, assuming pure risks, setting up and managing the risk portfolio, and transferring risk to other companies through passive reinsurance and co-insurance.
• Financial asset management: This involves administering the financial assets that arise from premium payments.