Financial Institutions and Markets

-

 Financial Institutions and Markets:

Most successful firms have ongoing needs for funds. They can obtain funds from external sources in three ways. The first source is through a financial institution that accepts savings and transfers them to those that need funds. A second source is through financial markets, organized forums in which the suppliers and demanders of various types of funds can make transactions. A third source is through private placement.

FINANCIAL INSTITUTIONS:

  • Financial institutions serve as intermediaries by channeling the savings of individuals, businesses, and governments into loans or investments. 
  • Many financial institutions directly or indirectly pay savers interest on deposited funds; others provide services for a fee (for example, checking accounts for which customers pay service charges). 
  • Financial institutions are required by the government to operate within established regulatory guidelines.

Key Customers of Financial Institutions:

The key suppliers of funds to financial institutions and the key demanders of funds from financial institutions are individuals, businesses, and governments. The savings that individual consumers place in financial institutions provide these institutions with a large portion of their funds.

Major Financial Institutions:

The major financial institutions in the U.S. economy are commercial banks, savings and loans, credit unions, savings banks, insurance companies, mutual funds, and pension funds.


COMMERCIAL BANKS, INVESTMENT BANKS, AND THE SHADOW BANKING SYSTEM:

Investment banks and commercial banks represent two divisions of the banking industry, and each type provides substantially different services.

Investment banks expedite the purchase and sales of bonds, stocks, and other investments, and aid companies in making initial public offerings (IPOs) when they first go public and sell shares. Commercial banks act as managers for deposit accounts belonging to businesses and individuals, although they are primarily focused on business accounts, and they make public loans from the deposited money they hold.

Commercial banks are among the most important financial institutions in the economy because they provide savers with a secure place to invest funds and they offer both individuals and companies loans to finance investments, such as the purchase of a new home or the expansion of a business.

 Investment banks are institutions that:

(1) assist companies in raising capital

(2) advise firms on major transactions such as mergers or financial restructurings

(3) engage in trading and market-making activities.

Shadow banking system:

A group of institutions that engage in lending activities, much like traditional banks, but these institutions do not accept deposits and are therefore not subject to the same regulations as traditional banks.

For example, an institution such as a pension fund might have excess cash to invest, and a large corporation might need short-term financing to cover seasonal cash flow needs.

Comments

Post a Comment

Popular posts from this blog

Risk of a Single Asset

-
Image
 Risk of a Single Asset: The concept of risk can be developed by first considering a single asset held in isolation. We can look at expected-return behaviors to assess risk, and statistics can be used to measure it.  Risk Assessment: Sensitivity Analysis (Scenario Analysis) and Probability Distributions can be used to assess the general level of risk embodied in a given asset. Sensitivity Analysis: Sensitivity analysis uses several possible-return estimates to obtain a sense of the variability among outcomes. One common method involves making pessimistic (worst), most likely (expected), and optimistic (best) estimates of the returns associated with a given asset. In this case, the asset’s risk can be measured by the range of returns. The range is found by subtracting the pessimistic outcome from the optimistic outcome. The greater the range, the more variability, or risk, the asset is said to have. Although the use of sensitivity analysis and the range is rather crude, it does...
Read more

Secured Bond

-
Image
What are Secured Bonds? A secured bond is a  bond  that requires the issuer to pledge specific assets as collateral in the case of default. Secured bonds are usually more popular with businesses or governments that are less likely to be able to pay their debts in the future. Interest on these bonds isn’t enough to attract investors. Companies and local governments will less than stellar past financial track records usually need to assure inventors that they will not default on their future principle and interest payments. And if they do default, ensure the investors don’t walk away empty handed.   Example A good example of a local government that will probably need to issue secured bonds in the future is the city of Detroit. Since its 2013 bankruptcy, its difficult to believe an investor would want to put his or her money at risk purchasing a bond issued by the city of Detroit. I doubt it will ever be able to issue a bond without having some kind of secured collateral agr...
Read more

Types of Corporates bonds

-
Image
Types of Corporates bonds:  There are five basic categories of corporate bonds: public utilities, transportations, industrials, banks and finance companies, and international issues. The five categories can be further broken down. For example, the transportation category includes airlines, railroads, and trucking companies. Security of bonds Security for bonds suggests some kind of underlying asset that backs up the issue. This is preferable for investors, as it provides risk protection against a potential corporate  default . Assets backing the bond provide security beyond the credit of the issuer. M ortgage bond A mortgage bond is a secured bond issued by a company. With a mortgage bond, the company pledges specific assets as a collateral for the bond. The asset securing the bond is described in detail in the mortgage deed, which is a legal document giving the bondholder a lien on an asset. A company can use a specific asset as security for more than one bond issue. In the e...
Read more

Unsecured Bonds

-
Image
What are Unsecured Bonds? Unsecured bonds or debentures are bonds that are not backed by some type of collateral. In other words, the bond is only secured by the bond issuer’s good credit standing. There are no building, equipment, vehicles, or other assets backing up the bond. If the bond issuer defaults on the unsecured bond, the bond holders could receive nothing from their investment. They would be left up to the court system to sue the bond issuer for their investment.  A bond that has no specified source of collateral is considered an unsecured debt instrument. Therefore, unsecured debt often pays higher yields than secured debt due to lack of a direct collateral coverage. There are three types of unsecured debt: debentures, Income bonds and subordinated debentures. Debentures A debenture is a type of bond that does not use collateral. It's otherwise recognized as any unsecured long-term debt. Because the bonds are unsecured, it's imperative for the issue to be profitable...
Read more

Constant-Growth Model

-
Image
Constant-Growth Model The most widely cited dividend valuation approach, the constant-growth model, assumes that dividends will grow at a constant rate, but a rate that is less than the required return. The constant-growth model is commonly called the Gordon model. The Gordon Growth Model – otherwise described as the dividend discount model – is a stock valuation method that calculates a stock’s intrinsic value. Therefore, this method disregards current market conditions. Investors can then compare companies against other industries using this simplified model. The Gordon Growth Model (GGM) is used to determine the intrinsic value of a stock based on a future series of dividends that grow at a constant rate. It is a popular and straightforward variant of the dividend discount model (DDM). The GGM assumes that dividends grow at a constant rate in perpetuity and solves for the present value of the infinite series of future dividends. Because the model assumes a constant growth rate, it i...
Read more