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Chapter 2. Financial Intermediaries & Financial Innovation

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Presentation on theme: "Chapter 2. Financial Intermediaries & Financial Innovation"— Presentation transcript:

1 Chapter 2. Financial Intermediaries & Financial Innovation
financial institutions role of financial intermediaries asset/liability management financial innovation

2 I. Financial Institutions
provide financial services transforming financial assets (own one type, issue another type) trade financial assets create & sell assets on behalf of others investment advice & management

3 depository institutions
acquire funds mostly from deposits nondepository institutions acquire funds from other sources

4 II. Role of Financial Intermediaries
raise funds FOR direct investment their assets stock, bonds, loans raise funds BY indirect investment issue their own liabilities accept deposits, sell insurance policies sell mutual funds shares

5 indirect investments allow investors
choice of desired maturity maturity intermediation diversification w/ small amount of capital lower transactions costs alternative payment mechanisms

6 III. Asset/liability Managment
liabilties = claims on financial institution liabilities differ in the certainty about their amount and timing

7 Type I Liabilities timing and amount is certain fixed rate bank CD
GIC (guaranteed investment contract) (principal and fixed interest payment due on specified date)

8 Type II Liabilities amount is certain, timing is not
term life insurance policy (amount of policy is known, but timing of death is not)

9 Type III Liabilities amount not certain, but timing is
variable rate bank CD (know the maturity date, but not size of interest payment)

10 Type IV Liabilities amount and timing uncertain auto insurance policy
property insurance policy (how much is the damage? when will damage occur?)

11 type of liabilities issued determines the types of assets bought & held
long-term or short-term? risk?

12 IV. Financial Innovation
creation of new financial assets new ways to use financial assets dramatic in past 30 years

13 why does it happen? changing times/ new risks increased volatility in
-- interest rates -- stock prices -- exchange rates led to development of derivatives

14 advances in technology
rapid flow of information rapid calculation of risks and prices rapid trading competition among institutions for products for strategies

15 circumvent regulations, tax laws
NOW accounts in 1970s “selling short against the box” sophistication of market professionals devise & use complex securities price complex securities

16 Asset securitization take individual loans pool them together
issue & sell securities w/ cash flow back by the loan pool payments

17 old way: bank originates mortgage bank holds mortgage & collects payments until loan is paid new way: bank sells mortgage to Fannie Mae bank gets fee for servicing mortgage Fannie Mae issues securities

18 advantages bank capital not tied up in loans
institutions specialize in part of process pool of loans is diversified (less risk) loans are more liquid easier to get cheaper to get


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