Fin 421 Ch.1

Compare the main sources and uses of funds for finance companies, insurance companies, and pension funds.

Finance companies sell securities to obtain funds, while insurance companies receive insurance premiums and pension funds receive employee/employer contributions. Finance companies use funds to provide direct loans to consumers and businesses. Insurance companies and pension funds purchase securities.

Integrate the roles of accounting, regulations, and financial market participation.

Financial market participants rely on financial information that is provided by firms

What is the function of a mutual fund? Why are mutual funds popular among investors? How does a money market mutual fund differ from a stock or bond mutual fund?

-A mutual fund sells shares to investors, pools the funds, and invests the funds in a portfolio of securities. -Mutual funds are popular because they can help individuals diversify while using professional expertise to make investment decisions. -A money market mutual fund invests in money market securities, whereas other mutual funds normally invest in stocks or bonds.

Classify the types of financial institutions as either depository or non-depository. Explain the difference between depository and non-depository institution sources of funds.

-Depository institutions: commercial banks, savings and loan associations, and credit unions. -Non-depository institutions: finance companies, insurance companies, pension funds, mutual funds, and money market funds. -These institutions differ because non-depository institutions do NOT accept deposits.

Explain why the credit crisis caused a lack of liquidity in the secondary markets for many types of debt securities. Explain how such a lack of liquidity would affect the prices of debt securities in the secondary markets.

-Investors were less willing to invest in many debt securities because they were concerned that these securities might default. -As investors reduced their investments, the secondary markets for these debt securities became illiquid. -If there are many sellers of debt securities in the secondary market, and not many buyers, the prices of these securities should decline.

Distinguish between primary and secondary markets. Distinguish between money and capital markets.

-Primary Markets: issuance of new securities. Secondary Markets: trading of existing securities. -Money Markets: trading of short-term instruments. Capital markets: trading of long-term securities.

Explain why mortgage defaults during the credit crisis adversely affected financial institutions that did not originate the mortgages. What role did these institutions play in financing the mortgages?

-Some financial institutions participated by issuing mortgage-backed securities that represented mortgages originated by mortgage companies. -Mortgage-backed securities performed poorly during the credit crisis in 2008 because of the high default rate on mortgages. -Some financial institutions that held a large amount of mortgage-backed securities suffered major losses at this time

Different types of financial institutions commonly interact. They provide loans to each other, and take opposite positions on many types of financial agreements, whereby one will owe the other based on a specific financial outcome. Explain why their relationships cause concerns about systematic risk.

-When financial institutions interact through transactions, the failure of one financial institution can cause financial problems for others. -Many financial institutions might be unable to cover their obligations, and this spreads fear that the financial system might collapse.

With regard to the profit motive, how are credit unions different from other financial institutions?

Credit unions are non-profit financial institutions.

Explain the meaning of efficient markets. Why might we expect markets to be efficient most of the time?

If markets are efficient then prices of securities available in these markets properly reflect all information. We should expect markets to be efficient because if they weren't, investors would capitalize on the discrepancy between what prices are and what they should be.

Explain the primary use of funds for commercial banks versus saving institutions.

Saving institutions have traditionally concentrated in mortgage lending, while commercial banks have concentrated in commercial lending. Saving institutions are now allowed to diversify their asset portfolio to a greater degree and will likely increase their concentration in commercial loans.

Commercial banks use some funds to purchase securities and other funds to make loans. Why are the securities more marketable than loans in the secondary market?

Securities are more standardized than loans and therefore can be more easily sold in the secondary market. The excessive documentation on commercial loans limits a bank's ability to sell loans in the secondary market.