Professional Documents
Culture Documents
Indirect finance
Borrowers and lenders meet through a financial intermediary (e.g. bank) Loan is a liability for borrower, and asset for a bank
Direct finance
Borrowers sell securities directly to lenders e.g. corporate and Treasury bonds
I. Financial Instruments
aka. securities, financial assets
definition (p. 36 (1st) or 41 (2nd)) = written legal obligation of one party to transfer something of value, usually money, to antoher party at some future date, under certain conditions
a security is an asset for the buyer/lender, but a liability for the issuer/borrower/seller
example
my mortgage
I am the borrower (liability) the bank is the buyer/holder (asset) the bank has a claim on my house
means of payment but much less liquid than money store of value better than money over time, but also greater risk transfer of risk buyer transfers risk to seller e.g. insurance policies, futures contract
sizing, timing & certainty of promised cash flows Size: how much is promised? the larger the cash flows, the greater the value Timing: when is it promised? the sooner the cash flows are received, the greater the value
Certainty: how likely its it that payments will be made? the likelier the payments the greater the value Under what conditions? e.g. insurance, derivatives payments when we need them the most are more valuable
bank loans stocks bonds home mortgages asset-backed securities option and futures contracts insurance policies
primary market
newly issued securities -- investment banking secondary market brokers match buyers and sellers dealers act as buyers and sellers -- market-makers
debt security
cash flows are fixed bonds, loans equity security cash flow variable, residual common stock
exchange
buying & selling of securities in physical location NYSE OTC (over-the-counter) dealers in many locations buy & sell securities
money market
short-term debt securities (up to 1 yr.) highly liquid, low risk capital market longer-term debt equity
Money Market
3% 9% 0% 4% 20%
U.S. Tbills CDs Commercial Paper Banker's Acceptances Repos Federal Funds Eurodollars
39%
25%
Capital Market
4% 11% 8%
18%
59%
Risk sharing
intermediaries are experts at bearing risk Asset transformation short-term to long-term illiquid to liquid
Types of intermediaries
Depository institutions
banks accept deposits, make loans
Commercial banks
largest in total assets least restricted Savings & Loans originally restricted to savings deposits and mortgages less restricted today Credit Unions consumer loans nonprofit, organized around a group
Nondepository institutions
insurance companies pension funds finance companies
Mortgage, auto, office equipment
securities firms
Citigroup, Merrill Lynch
GSEs
Fannie Mae, Freddie Mac