'Finance Management Essay\r'

'In a ground without FIs the procedurers of corporeal currency in the preservation would construct to approach at maven time the ho workouthold savers of bills in order to satisfy their borrowing emergencys. This assist would be extremely comprisely because of the up-front reading bell faced by electric potential loaners. Cost inefficiencies would attire with the identification of potential borrowers, the pooling of footling savings into loans of enough size to finance corporate activities, and the assessment of jeopardize and induement opportunities.\r\nMoreover, lenders would pass water to reminder the activities of borrowers over to each one loan’s disembodied spirit span. The net prove would be an imperfect parceling of resources in an providence. 3. point and explain three stinting disincentives that probably would yield the flow of bills mingled with household savers of funds and corporate users of funds in an economic world without pe cuniary intermediaries. Investors popularly be averse to secure securities outright because of (a) remindering cost, (b) liquid state cost, and (c) scathe pretend.\r\nmonitor the activities of borrowers requires extensive time, expense, and expertise. As a result, households would prefer to resign this activity to others, and by definition, the resulting lack of monitoring would growth the encounteriness of identifying in corporate debt and fairness food markets. The long-term nature of corporate comeliness and debt would promising eliminate at least a allot of those households leave aloneing to lend silver, as the preference of virtually for near-cash liquidity would dominate the extra returns which whitethorn be available.\r\nThird, the price risk of performances on the substitute markets would increase without the discipline flows and gains growd by towering volume. 4. Identify and explain the two hunt d avers in which FIs may specialize that enab le the smooth flow of funds from household savers to corporate users. FIs serve as conduits between users and savers of funds by providing a brokerage function and by engaging in the as get up novelty function. The brokerage function deal advance both savers and users of funds and can vary according to the firm.\r\nFIs may tolerate only transaction advantages, much(prenominal) as tax deduction brokerages, or they in addition may exsert advisory run which help overcome entropy be, much(prenominal) as replete(p)-line firms like Merrill Lynch. The summation duty period function is accomplished by issuing their own securities, such as deposits and amends policies that be much than attractive to household savers, and using the proceeds to obtain the first-string securities of corporations. thitherfrom, FIs be deal on the costs associated with the corrupt of securities. 5.\r\nIn what reek ar the monetary claims of FIs considered lowly securities, go the m onetary claims of technical corporations argon considered primary securities? How does the transformation influence, or intermediation, reduce the risk, or economic disincentives, to the savers? The funds raised by the fiscal claims issued by mercantile-grade corporations argon used to invest in real assets. These financial claims, which argon considered primary securities, are purchased by FIs whose financial claims therefore are considered standby securities.\r\nSavers who invest in the financial claims of FIs are substantiatively investiture in the primary securities of commercial corporations. However, the knowledge gathering and evaluation expenses, monitoring expenses, liquidity costs, and price risk of placing the enthronements directly with the commercial corporation are reduced because of the efficiencies of the FI. 6. Explain how financial institutions act as delegated monitors. What secondary benefits a lottimes accrue to the entire financial system because of this monitoring exhibit?\r\nBy set superfluity funds into financial institutions, one-on-one investors kick down to the FIs the responsibility of deciding who should fulfil the bullion and of ensuring that the gold is utilized properly by the borrower. In this sense the depositors redeem delegated the FI to act as a monitor on their behalf. The FI can collect information more expeditiously than someone investors. Further, the FI can utilize this information to earn new products, such as commercial loans, that continually update the information pool.\r\nThis more shit monitoring process sends primal informational signals to other participants in the market, a process that reduces information imperfection and unbalance between the ultimate sources and users of funds in the rescue. 7. What are atomic number 23 general areas of FI specialness that are caused by providing various service to sectors of the economy? First, FIs collect and process information more efficien tly than mortal savers. Second, FIs allow for secondary claims to household savers which often take over go liquidity characteristics than primary securities such as quities and bonds. Third, by diversifying the asset base FIs provide secondary securities with pull down price-risk conditions than primary securities. Fourth, FIs provide economies of scale in transaction costs because assets are purchased in erectr centres. Finally, FIs provide maturity intermediation to the economy which allows the introduction of spare types of investment contracts, such as mortgage loans, that are financed with short-term deposits. 8. How do FIs solve the information and related to agency costs when household savers invest directly in securities issued by corporations?\r\nWhat are agency costs? Agency costs occur when owners or managers take actions that are not in the dress hat interests of the equity investor or lender. These costs typically result from the nonstarter to adequately m onitor the activities of the borrower. If no other lender performs these tasks, the lender is subject to agency costs as the firm may not satisfy the covenants in the lending agreement. Because the FI invests the funds of m both small savers, the FI has a greater incentive to collect information and monitor the activities of the borrower. 9.\r\nWhat often is the benefit to the lenders, borrowers, and financial markets in general of the solution to the information problem provided by the braggart(a) financial institutions? one(a) benefit to the solution process is the development of new secondary securities that allow change surface further improvements in the monitoring process. An example is the aver loan that is renewed more quickly than long-term debt. The renewal process updates the financial and in functioning(p) information of the firm more frequently, thereby reducing the drive for restrictive bond covenants that may be fractious and costly to implement. 10.\r\nHow do FIs alleviate the problem of liquidity risk faced by investors who wish to invest in the securities of corporations? Liquidity risk occurs when savers are not able to sell their securities on take on. Commercial swears, for example, hug drug deposits that can be withdrawn at any time. Yet the banks eviscerate long-term loans or invest in illiquid assets because they are able to diversify their portfolios and stop monitor the performance of firms that prevail borrowed or issued securities. Thus individual investors are able to realize the benefits of investing in primary assets without accepting the liquidity risk of direct investment. 1. How do financial institutions help individual savers diversify their portfolio risks? Which type of financial institution is lift out able to achieve this goal? Money set in any financial institution will result in a claim on a more diversified portfolio. Banks lend cash to more different types of corporate, consumer, and government custo mers, and insurance companies beat investments in many different types of assets. Investment in a vulgar fund may generate the greatest diversification benefit because of the fund’s investment in a wide order of stocks and fixed income securities. 2. How can financial institutions invest in wondering(a) assets with funding provided by low-risk liabilities from savers? Diversification of risk occurs with investments in assets that are not perfectly positively correlated. One result of extensive diversification is that the bonnie risk of the asset base of an FI will be less than the average risk of the individual assets in which it has invested. Thus individual investors realize some of the returns of high-risk assets without accepting the corresponding risk characteristics. 13.\r\nHow can individual savers use financial institutions to reduce the transaction costs of investing in financial assets? By pooling the assets of many small investors, FIs can gain economies of sc ale in transaction costs. This benefit occurs whether the FI is lending to a corporate or retail customer, or purchasing assets in the money and detonator markets. In either carapace, operating(a) activities that are intentional to deal in grown volumes typically are more efficient than those activities designed for small volumes. 14. What is maturity intermediation?\r\nWhat are some of the ways in which the risks of maturity intermediation are managed by financial intermediaries? If net borrowers and net lenders have different optimal time horizons, FIs can service both sectors by matching their asset and indebtedness maturities through on- and off-balance sheet hedging activities and flexible gate to the financial markets. For example, the FI can offer the relatively short-term liabilities desired by households and also satisfy the demand for long-term loans such as home mortgages.\r\nBy investing in a portfolio of long-and short-term assets that have variable- and fixed-rate components, the FI can reduce maturity risk photo by utilizing liabilities that have similar variable- and fixed-rate characteristics, or by using futures, picks, swaps, and other derivative products. 15. What are five areas of institution-specific FI specialness, and which types of institutions are most likely to be the service providers? First, commercial banks and other depository institutions are break players for the transmitting of monetary policy from the central bank to the rest of the economy.\r\nSecond, specific FIs often are identify as the major source of finance for genuine sectors of the economy. For example, S;Ls and savings banks traditionalisticly serve the course credit requisites of the residential real estate market. Third, disembodied spirit insurance and allowance funds commonly are encouraged to provide mechanisms to counterchange wealthiness across generations. Fourth, depository institutions efficiently provide payment services to benefit the e conomy. Finally, mutual funds provide appellative intermediation by allowing small investors to purchase pieces of assets with striking minimum sizes such as negotiable CDs and commercial paper issues. 6. How do depository institutions such as commercial banks assist in the executing and transmitting of monetary policy? The Federal Reserve bestride can involve directly the commercial banks in the implementation of monetary policy through changes in the reserve requirements and the discount rate. The open market change and purchase of Treasury securities by the Fed involves the banks in the implementation of monetary policy in a less direct manner. 17. What is meant by credit allocation law?\r\nWhat societal benefit is this type of commandment intended to provide? Credit allocation polity refers to the requirement faced by FIs to lend to genuine sectors of the economy, which are considered to be socially important. These may accept housing and farming. Presumably the prov ision of credit to make houses more affordable or farms more viable leads to a more stable and productive purchase order. 18. Which intermediaries best fulfill the intergenerational wealth change function? What is this wealth transfer process?\r\nLife insurance and indemnity funds often receive special gross relief and other subsidies to assist in the transfer of wealth from one generation to another. In effect, the wealth transfer process allows the accumulation of wealth by one generation to be transferred directly to one or more younger generations by establishing life insurance policies and trust provisions in pension plans. Often this wealth transfer process rid ofs the full marginal tax treatment that a direct payment would incur. 19. What are two of the most important payment services provided by financial institutions?\r\nTo what termination do these services efficiently provide benefits to the economy? The two most important payment services are check clearing and wi re transfer services. Any breakdown in these systems would produce gridlock in the payment system with resulting harmful effects to the economy at both the domestic and potentially the planetary level. 20. What is denomination intermediation? How do FIs assist in this process? Denomination intermediation is the process whereby small investors are able to purchase pieces of assets that normally are sell only in large denominations.\r\nsomebody savers often invest small amounts in mutual funds. The mutual funds pool these small amounts and purchase negotiable CDs which can only be sold in minimum increments of $100,000, but which often are sold in million dollar packages. Similarly, commercial paper often is sold only in minimum amounts of $250,000. Therefore small investors can benefit in the returns and low risk which these assets typically offer. 21. What is damaging externality? In what ways do the being of prohibit externalities justify the extra restrictive fear received by financial institutions?\r\nA negative externality refers to the action by one political party that has an adverse affect on some terzetto party who is not part of the original transaction. For example, in an industrial setting, smoke from a factory that lowers adjoin property hold dears may be viewed as a negative externality. For financial institutions, one foreboding is the contagion effect that can arise when the failure of one FI can cast doubt on the solvency of other institutions in that industry. 22. If financial markets operated perfectly and costlessly, would there be a need for financial intermediaries?\r\nTo a certain extent, financial intermediation hold ups because of financial market imperfections. If information is available costlessly to all participants, savers would not need intermediaries to act as either their brokers or their delegated monitors. However, if there are social benefits to intermediation, such as the transmission of monetary policy or credi t allocation, indeed FIs would exist even in the absence of financial market imperfections. 23. What is mortgage redlining? Mortgage redlining occurs when a lender specifically defines a geographic area in which it refuses to make any loans.\r\nThe term arose because of the area often was outlined on a map with a red pencil. 24. Why are FIs among the most set sectors in the world? When is net regulatory magnetic core positive? FIs are required to enhance the efficient operation of the economy. Successful financial intermediaries provide sources of backing that fund economic growth opportunity that lastly raises the overall level of economic activity. Moreover, successful financial intermediaries provide transaction services to the economy that quicken trade and wealth accumulation.\r\nConversely, damageed FIs create negative externalities for the entire economy. That is, the adverse impact of an FI failure is greater than just the loss to shareholders and other private claiman ts on the FI’s assets. For example, the local market suffers if an FI fails and other FIs also may be thrown into financial distress by a contagion effect. Therefore, since some of the costs of the failure of an FI are generally borne by society at large, the government intervenes in the management of these institutions to comfort society’s interests. This intervention takes the form of linguistic rule.\r\nHowever, the need for regulation to minimize social costs may impose private costs to the firms that would not exist without regulation. This surplus private cost is defined as a net regulatory marrow. Examples allow in the cost of holding excess capital and/or excess militia and the extra costs of providing information. Although they may be socially beneficial, these costs add to private operating costs. To the extent that these additional costs help to avoid negative externalities and to ensure the smooth and efficient operation of the economy, the net regula tory angle is positive. 5. What forms of protection and regulation do regulators of FIs impose to ensure their safety and firmness of purpose? Regulators have issued several guidelines to insure the safety and wisdom of FIs: a. FIs are required to diversify their assets. For example, banks cannot lend more than 10 part of their equity to a virtuoso borrower. b. FIs are required to maintain minimum amounts of capital to cushion any unexpected losses. In the case of banks, the Basle standards require a minimum core and secondary capital of 8 percent of their risk-adjusted assets. c.\r\nRegulators have set up guaranty funds such as BIF for commercial banks, SIPC for securities firms, and state guaranty funds for insurance firms to protect individual investors. d. Regulators also engage in periodic monitoring and surveillance, such as on-site examinations, and request periodic information from the FIs. 26. In the transmission of monetary policy, what is the difference between insi de money and outside money? How does the Federal Reserve get along with try to control the amount of inside money? How can this regulatory position create a cost for the depository financial institutions?\r\nOutside money is that part of the money supply directly produced and controlled by the Fed, for example, coins and currency. Inside money refers to bank deposits not directly controlled by the Fed. The Fed can influence this amount of money by reserve requirement and discount rate policies. In cases where the level of required reserves exceeds the level considered optimal by the FI, the inability to use the excess reserves to generate revenue may be considered a tax or cost of providing intermediation. 27. What are some examples of credit allocation regulation?\r\nHow can this attempt to create social benefits create costs to the private institution? The qualified saving lender test (QTL) requires thrifts to hold 65 percent of their assets in residential mortgage-related asset s to retain the thrift adopt. close to states have enacted usury laws that place maximum restrictions on the interest rates that can be aerated on mortgages and/or consumer loans. These types of restrictions often create additional operating costs to the FI and almost certainly reduce the amount of profit that could be realized without such regulation. 8. What is the purpose of the Home Mortgage Disclosure round? What are the social benefits desired from the legislation? How does the implementation of this legislation create a net regulatory nitty-gritty on financial institutions? The HMDA was passed by coitus to prevent discrimination in mortgage lending. The social benefit is to ensure that everyone who qualifies financially is provided the opportunity to purchase a house should they so desire. The regulatory burden has been to require a written statement indicating the reasons why credit was or was not granted.\r\nSince 1990, the federal regulators have examined millions of mortgage transactions from more than 7,700 institutions each calendar quarter. 29. What legislation has been passed specifically to protect investors who use investment banks directly or indirectly to purchase securities? crack up some examples of the types of abuses for which protection is provided. The Securities make fors of 1933 and 1934 and the Investment Company Act of 1940 were passed by Congress to protect investors against possible abuses such as insider trading, lack of disclosure, outright malfeasance, and breach of fiducial responsibilities. 30.\r\nHow do regulations regarding barriers to entry and the scope of permitted activities affect the charter value of financial institutions? The profitability of existing firms will be increase as the direct and indirect costs of establishing competition increase. Direct costs embroil the actual physical and financial costs of establishing a business. In the case of FIs, the financial costs include raising the necessary minimum capital to receive a charter. Indirect costs include permission from regulatory authorities to receive a charter. once more in the case of FIs this cost involves acceptable lead to the regulators.\r\nAs these barriers to entry are stronger, the charter value for existing firms will be higher. 31. What reasons have been realisen(p) for the growth of investment companies at the expense of â€Å"traditional” banks and insurance companies? The upstart growth of investment companies can be attributed to two major factors: a. Investors have demanded change magnitude access to direct securities markets. Investment companies and pension funds allow investors to take positions in direct securities markets while still obtaining the risk diversification, monitoring, and transactional efficiency benefits of financial intermediation.\r\n many experts would argue that this growth is the result of increased sophistication on the part of investors; others would argue that the ability to use these markets has caused the increased investor awareness. The growth in these assets is inarguable. b. Recent episodes of financial distress in both the banking and insurance industries have led to an increase in regulation and governmental oversight, thereby increasing the net regulatory burden of â€Å"traditional” companies. As such, the costs of intermediation have increased, which increases the cost of providing services to customers. 2. What are some of the methods which banking organizations have employed to reduce the net regulatory burden? What has been the effect on profitability? Through regulatory changes, FIs have begun changing the mix of business products offered to individual users and providers of funds. For example, banks have acquired mutual funds, have expanded their asset and pension fund management businesses, and have increased the security underwriting activities. In addition, legislation that allows banks to establish branches anywhere in th e United States has caused a wave of mergers.\r\nAs the size of banks has grown, an expansion of possible product offerings has created the potential for lower service costs. Finally, the emphasis in recent years has been on products that generate increases in stipend income, and the entire banking industry has benefited from increased profitability in recent years. 33. What characteristics of financial products are necessary for financial markets to become efficient alternatives to financial intermediaries? Can you give some examples of the commoditization of products which were previously the sole property of financial institutions?\r\nFinancial markets can replace FIs in the voice communication of products that (1) have standardized equipment casualty, (2) serve a large number of customers, and (3) are sufficiently understood for investors to be comfortable in assessing their prices. When these three characteristics are met, the products often can be treated as commodities. On e example of this process is the migration of over-the-counter options to the publicly traded option markets as trading volume grows and trading terms become standardized. 34. In what way has Regulation 144A of the Securities and convert Commission provided an incentive to the process of financial disintermediation?\r\n'