Chapter 13
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Transcript of Chapter 13
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Chapter 13
Nonbank Finance
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Insurance
• Life insurance– Permanent (whole, universal, and variable)
– Term
• Property and Casualty– Hold more liquid assets than life insurance companies
– Reinsurance
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Insurance (cont’d)
• Competitive threat from the banking industry
• Credit insurance– Credit default swaps
• AIG case.
– Monoline insurance
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Table 1 Relative Shares of Total Financial Intermediary Assets, 1970–2008 (percent)
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Insurance Management
• To lower moral hazard and adverse selection– Screening
– Risk-based premiums
– Restrictive provisions
– Prevention of fraud
– Cancellation of insurance
– Deductibles
– Coinsurance
– Limits on the amounts of insurance
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Pension Funds
• Defined-contribution plan
• Defined-benefit plan– Fully-funded; underfunded
• Private pension plans– Employee Retirement Income Security Act (ERISA) of 1974• Pension Benefit Guarantee Corporation (PBGC, Penny Benny)
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Pension Funds (cont’d)
• Public pension plans– Social Security
• Pay as you go system.• Massive underfunding.• Possible reforms proposed.
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Finance Companies
• Virtually unregulated compared to commercial banks and thrifts institutions
• Sales finance companies• Consumer finance companies• Business finance companies
– Factoring – Leasing equipment
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Securities Market Operations
• Financial facilitators– Investment banks
– Securities brokers and dealers
– Organized exchanges
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Investment Banking
• Assist in the sale of securities– Advise the corporation on whether it should issue bonds or stock.
– Bonds: advise on maturity and interest payments
– Stocks: advice on price• Seasoned issues or initial public offering
– Underwrites
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Investment Banking (cont’d)
• Regulated by SEC– Registration statement– Provide potential investors with a prospectus
– 20 day waiting period
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Securities Brokers and Dealers
• Securities brokers and dealers conduct trading in secondary markets
• Brokers– Agents for investors, match buyers and sellers– Paid brokerage commission
• Dealers– Stand ready to buy and sell– Hold inventories– Paid by the ‘spread’
• Brokerage firms– Act as brokers, dealers, and investment bank– Regulated by SEC
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Organized Exchanges
• NYSE: largest organized exchange in the world.
• Hybrid of auction market and dealer market. • Specialist• Regulated by SEC
– Authority to impose regulation and to alter the rules set by the exchanges
• Securities Amendments Act of 1975• Growing internationalization
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Mutual Funds
• Pool the resources of many small investors by selling shares and using the proceeds to buy securities
• Sovereign wealth funds– Estimated to hold $3 trillion in assets
– Concerns• Size (can cause market instability)
• National security issues
• Provide very little information about their operations
• Open-end fund and closed-end fund
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Mutual Funds (cont’d)
• Load funds and no-load funds
• Regulated by Securities and Exchange Commission
• Money market mutual funds– Function as checkable deposits that earn interest.
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Hedge Funds
• Similar to mutual funds but:– Minimum investment typically $1 million– No more than 99 investors– Net worth requirement for investors– Long-term commitment– Speculates on spreads
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Private Equity and Venture Capital Funds
• Private equity fund– Long-term investments in companies that are not traded in public markets.
• Two types– Venture capital funds– Capital buyout funds (leveraged buyout)
• Carried interest
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Government Financial Intermediation
• Mortgage market– GNMA, Ginnie Mae– FNMA, Fannie Mae (GSE)– FHLMC, Freddie Mac (GSE)
• Farm Credit System
• Federal Credit Reform Act of 1990
• The creation of GSEs has led to conflict of interest and moral hazard problems.