1. Chapter 13 Non depository Financial Institutions

2. Life Insurance Companies  Structure  Stock companies Owned and controlled by shareholders  Mutual associations Ownership and control rests with the policyholders  Supervision and regulation  States in which they operate

3. Life Insurance Companies  Regulation of life insurance companies includes:  Sales practices  Premium rates  Allowable investments  Usually overseen by  State insurance commissioner  State banking commissioner

4. Life Insurance Companies  Whole Life Insurance  Constant premium that is paid through entire life of policy  Includes a Savings component  Build up cash reserves or savings  Pays a money market rate of interest  Can be borrowed  Withdrawn by canceling the policy

5. Life Insurance Companies Term Life Insurance  Pure insurance with no cash reserve or savings element  Premiums are relatively low at first but increase with the age of the insured individual

6. Life Insurance Companies Universal Life Insurance  Whole life paid little interest on the savings component  Consumers bought term life for insurance and MMMF for savings  Universal life offered just that  Owner can elect how to allocate the savings component among a menu of investment options

7. Life Insurance Companies  Based on actuarial tables, life insurance companies have ability to predict cash flow  Typically insurance companies use excess funds to invest in:  Long-term corporate bonds and commercial mortgages  Offers higher yields  Unlikely of having to sell prior to maturity  Recently, they have started to invest in riskier ventures:  Common stock  Real estate

8. Pension Funds  Supplement Social Security Benefits after retirement.  Most pension fund assets are in employer- sponsored plans  Defined Benefit Plan  Benefits are defined by the plan at the begining.  Employer contributions are adjusted to meet the benefits

9. Pension Funds  Defined Benefit Plan  Fully Funded  When employer puts in enough funds to meet future obligations  Due to compounded interest rate  Vested  When benefits stays with the employee even if they leave the firm. It is based on length of employment

10. Defined Benefit Plan  Employee Retirement Income Security Act (ERISA) A federal act that designed safeguard employee pension rights. It imposes:  Reporting and Disclosure requirements  Reporting vesting and funding information  Investment standards  Pension Benefit Guaranty Corporation (PBGC) A federal plan that guarantees some benefits in defined benefit plans if company is unable to meet its pension liabilities

11. Defined Contribution Plans  Defined Contribution Plan  Benefits are not pre-defined rather depend upon the performance of the assets in the plan  Contribution may be made by employees or employers or a combination of the two  Employee contributions are tax deferred  Individual employee has the ability to choose the assets in which to invest  Aggressive when young  Conservative when it is time to retire  Avoids the problems of vesting and funding

12. Pension Funds Some of the common Pension Plans are  401(k):  Employee in for profit corporation  403(b):  Employee in not for profit corporation  Keogh Plans  Self-employed individuals  Individual Retirement Accounts (IRAs)  Working people who are not covered by company- sponsored pension plans

13. Insurance Companies  Property and Casualty Insurance Can not plan for their future cash requirements as predictably as life insurance companies  Tend to invest in:  liquid short-term securities  Highly liquid but lower yields  tax-free municipal bonds  Regulation and supervision  States in which they operate

14. Insurance Companies  State insurance commissions  Set ranges for rates  Enforce operating standards  Exercise overall supervision over company policies  Little or no federal regulation

15. Mutual Funds Definition  A mutual fund pools the funds of many small saver  Fund managers invest the money in a diversified portfolio of securities  Provides limited check writing ability

16. Mutual Funds Open-end Mutual Fund  Sells shares to the general public  Shares represent a proportionate ownership in a portfolio held by the fund  Shareholders can directly buy additional shares  Shareholders redeem shares at the Net Asset Value (NAV)

17. Mutual Funds Net Asset Value (NAV)  No Load Funds: Sold directly to public at the current NAV  Load Funds:  Sold through brokers  Buyer pays a sales commission

18. Mutual Funds Closed-end Mutual Funds  Issue a limited number of shares  Mutual fund company does not redeem their own shares on demand  Shares of closed-end funds are traded in the stock market through a third party

19. Mutual Funds  Regulation  Securities and Exchange Commission (SEC)  Primary objective of regulation  Enforcement of reporting and  Ensure adequate disclosure  Protect the investor  Families of mutual funds  Number of mutual funds operated under one management umbrella  Investors can easily transfer money across funds within the family

20. Finance Companies Consumer Finance Companies  Make consumer loans  Specialty Finance Company specializes in credit card financing Commercial Finance Companies  Make commercial loans usually on a secured (collateralized) basis  Loans not less riskier consumer loans, but more riskier than loans made by commercial banks  Lending is short-term  Borrows substantial amounts in commercial paper market

21. Finance Companies  Historically finance companies have played an important role in financing undercapitalized companies  Commercial finance companies originated the concept of Leveraged Buy Out (LBOs) which relies heavily on debt to pay for acquisition of a company  Captive Finance Companies Finance purchase of commercial and retail oriented businesses such as General Motors products (GMAC)

22. Securities Brokers and Dealers and Investment Banks  These financial institutions play a crucial role in the distribution and trading of huge amounts of securities  Investment banks  Sell and distribute new stocks and bonds directly from issuing corporations to original purchasers  League Tables rank investment banks by the volume of securities they underwrite  Underwriting is typically conducted through a syndicate which includes many investment banks and brokerage firms

23. Securities Brokers and Dealers and Investment Banks Investment banks  Investment banks derive a substantial amount of income from offering advice to firms involved in mergers and acquisitions  What price one firm should pay for another  How the transaction should be structured  Provide strategic advice in hostile takeovers—when one firm seeks to acquire another against the other’s wishes

24. Securities Brokers and Dealers and Investment Banks Brokers and Dealers  Involved in the secondary market, trading outstanding securities  Brokers match buyers and sellers and earn a commission  Dealers commit their own capital when the buying and selling of securities and hope to make profit on the transaction

25. Securities Brokers and Dealers and Investment Banks  Brokers and Dealers  Many of the nationwide stock exchange firms act as investment bankers, dealers, and brokers  Commercial banks, investment banks, and broker dealers have now combined under single holding company umbrellas

26. Venture Capital Funds  Venture capital funds, mezzanine debt funds, and hedge funds are usually not available to public investors and not registered with SEC  Funding comes from wealthy individuals or other financial institutions, possibly sponsored by brokerage firms and banks  Both venture capital funds and mezzanine debt funds provide an important source of funding to small and midsize companies  Financing by both venture and mezzanine funds is non-traded and held until maturity

27. Venture Capital Funds  Invest funds in start-up companies  Traditional bank financing for these firms in the early stage of growth would be very limited  The Venture Capital Fund takes a substantial equity stake in the firm  Although many start-up companies not successful, significant profit can be made on those that are successful  Receives profits when it takes the successful company public in an Initial Public Offering (IPO).

28. Mezzanine Debt Funds  Mezzanine Debt Funds  Provide debt funds to small and midsize companies  Issue convertible debt and subordinated debt  Sometimes simply invest in a combination of high-yielding debt and equity issued by the same company  Used to provide long-term funds, sometimes part of a management-buyout financing package