Institutions & Derivative Instruments Financial Markets, Institutions & Derivative Instruments ECO 473 – Money & Banking – Dr. D. Foster
Economic Functions of Financial Markets Match savers and investors Savers want to wealth Investors want to create wealth Spread/share risk. Successful strategy - diversification Savers seek out mutual funds Savers seek out financial intermediaries Investors seek OPM
Financial Markets - Why & Who Why - Intermediation Who . . . banks credit unions S&Ls thrifts savings banks pension funds Insurance companies mutual funds mortgage brokers investment bankers finance companies
Government Players Federal Financing Bank Banks for Cooperatives Federal Intermediate Credit Banks Federal Land Banks Federal National Mortgage Association (FNMA, or “Fannie Mae”) General National Mortgage Association (GNMA, or “Ginnie Mae”) Federal Home Loan Banks (FHLBs) Federal Home Loan Mortgage Corporation (FHLMC, or “Freddie Mac”)
Financial Markets - New & Used New - Primary Markets stocks (IPO), bonds, mortgages, other. Used - Secondary Markets exchange of ownership. Where: NYSE, NASDAQ, OTC . . .
Financial Markets - Short & Long Short - Money Markets A financial instrument that matures w/in one year. Used to facilitate liquidity demands. Need funds soon. Have excess cash. Fed’l funds Repurchase agreements Bankers’ acceptances Euro$ funds 3 mo. & 6 mo. T-Bills Commercial paper Bank CDs
Money Market Instruments Outstanding, 2000-2012
Financial Markets - Short & Long Long - Capital Markets Maturities of more than one year. Used for capital purchases (investment). Less liquid & more risk than MM. Corporate stock Corporate bonds U.S. Treasury bonds Other U.S. & Munis Mortgages Comm./Con. loans
Capital Market Instruments Outstanding, 2012
What Assets Should Savers Hold? 1900 - 2007: Stocks 8% real; bonds 2% real Stocks returns are more volatile. Trade-off is between risk and return. Age is an issue. Can you pick stocks? No - Efficient Market Hypothesis. There can’t be systematically undervalued securities. 10
Financial Institutions Mutual Funds Sell diversification to individual savers. Government regulations limit risks. 8,000 mutual funds in the United States. Hedge Funds Raise money from wealthy people/institutions Largely unregulated Use leverage which magnifies gains/losses. Trade in derivative instruments. 11 11
Brokers and Dealers Investment Banks A broker buys and sells securities for others May be “full service” or “discount.” A dealer buys and sells for itself, making a market in these securities. Investment Banks Underwrites and advises companies on mergers and acquisitions. Investment banks buy and sell securities and derivatives. 12
The End of Investment Banks? 1930s regulations 2008 - collapse of the MBS market. Bear Stearns - couldn’t roll over debt. Lehman Brothers - $639 bill. in assets. Merrill Lynch - sold to BoA Goldman Sachs & Morgan Stanley- converted to commercial banks.
Case Study – 2004 Google IPO Google structured IPO as a “Dutch” auction. Google saved on investment bank services. Presumption is Google will earn more $$. Had touted a price of $135 earlier. Ended up with a price of $85. Earned $1.67 billion on sale. Conclusion: Investment underwriters are not biased!
Case Study – 2004 Google IPO 8/2012 trading at about $542 After IPO, At peak, traded at almost $715 8/2012 trading at about $542 After IPO, traded at $106 $1106 – 9/23/2018 15 15
Institutions & Derivative Instruments Financial Markets, Institutions & Derivative Instruments ECO 473 – Money & Banking – Dr. D. Foster