Financial Markets and Institutions

Venture capital firms look for these two things in making their decisions to invest in a firm.

1. A high return 2. Easy exit

What are the four broad classes of commercial banks loans?

1. Business or Commercial and Industrial Loans 2. Commercial and Residential Real Estate Loans 3. Individual Loans 4. "Other" Loans

Correspondent banking services include these for activities.

1. Check clearing and collection 2. Foreign exchange trading 3. Hedging services 4. Participation in large loan and security issuances

Commercial bank equity capital consists mainly of these three things.

1. Common and Preferred Stock (listed at par value) 2. Surplus or additional paid-in capital 3. Retained Earnings

What are the two major sources of funds for commercial banks?

1. Deposits 2. Borrowed or other liability funds.

__________: are potentially the riskiest of the financial securities in which investment banks make the market.

Derivative securities.

Investment banks are major market makers in the ___________ markets.

Derivatives securities.

A stockbroker that conducts trades for customers but does not offer investment advice.

Discount Broker

_____: the coexistence of both nationally and state-chartered banks, as in the United States.

Dual banking system

________: involves direct access, via the Internet, to the trading floor, therefore bypassing traditional brokers.

Electronic Brokerage

True or False: Commercial banks are highly leveraged and therefore hold major equity compared to total assets.

False, commercial banks are highly leveraged and therefore hold LITTLE equity compared to total assets.

True or False: generally, the balance sheet of a bank reflects the total scope of bank activities.

False, does not reflect the total scope of bank activities.

True of False: Commercial paper is available to most companies and individuals.

False, only the largest corporations can tap the commercial paper market.

True of False: Many investment securities held by banks are highly liquid, have high default risk, and can not easily be traded in secondary markets.

False, securities held by banks are highly liquid, have LOW default risk, and can usually be traded in secondary markets.

True or False: securities trading and underwriting is a financial service that requires relatively large investments in assets or liability funding?

False, securities trading and underwriting is a financial service that requires relatively LITTLE investment in assets or liability funding.

_______: insures the deposits of commercial banks.

Federal Deposit Insurance Corporation (FDIC)

________: an interbank market for short-term borrowing and lending of bank reserves.

Federal Funds Market

_________: is involved in the day-to-day regulation of trading practices.

Financial Industry Regulatory Authority (FINRA)

When is an item or activity considered an off-balance-sheet asset?

If, when a contingent even occurs, the item or activity moves onto the asset side of the balance sheet or an income item is realized on the income statement.

How are packaged (securitized) mortgage loans sold?

In secondary markets in the form of bonds.

________: the simultaneous buying and selling of a portfolio of at least 15 different stocks valued at more than $1 million, using computer programs to initiate such trades.

Program Trading

_________: entails buying an asset in one market at one price and selling it immediately in another market at a higher price.

Pure Arbitrage

What is the effect of additions to the reserve for loan and lease losses account?

Reduces retained earnings, and, thus, reduces the equity of the banks.

_____: a bank that engages in a complete array of wholesale commercial banking activities.

Regional or Superregional Banks

_____: consumer-oriented banking, such as providing residential and consumer loans and accepting smaller deposits.

Retail Banking

________: involves buying securities in anticipation of some information release--such as a merger or takeover announcement.

Risk Arbitrage

Do large or small banks tend to have a higher ROA?

Smaller banks

________: involves the trading of securities on behalf of individuals who want to transact in the money or capital markets.

Stock Brokerage

True or False: Since their introduction in 1980, interest-bearing checking accounts, especially NOW accounts, have dominated the transaction accounts of banks.

True

True or False: the liability structure of banks' balance sheets tends to reflect a shorter maturity structure than that of their asset portfolio.

True

True or False: the majority of assets held by commercial banks are loans?

True

True of False: Even a relatively small amount of loan defaults can wipe out the equity of a bank, leaving it insolvent.

True.

________: the trust department of a commercial banks holds and manages assets for individuals or corporations.

Trust Services

Commercial banks engage in other fee-generating activities that cannot easily be identified from analyzing their on- and off-balance sheet accounts. Two of these activities are _____ and _____.

Trust Services Correspondent Banking

Assisting in the issue of new securities.

Underwriting

A professionally managed pool of money used to finance new and often high-risk firms.

Venture Capital

True or False: Off-balance-sheet activities also involve engaging in derivative transactions--futures, forwards, options, and swaps.

True

True or False: Savings Institutions and Credit Unions are also depository institutions.

True

Securities Firms and Investment Banks engage in these eight key activity areas.

1. Investment Banking 2. Venture Capital 3. Market Making 4. Trading 5. Investing 6. Cash Management 7. Mergers and Acquisitions 8. Other Service Functions

What are the six types of trading activities?

1. Position Trading 2. Pure Arbitrage 3. Risk Arbitrage 4. Program Trading 5. Stock Brokerage 6. Electronic Brokerage

Most, if not all, money center banks are located where?

A major financial center.

__________: Two-way transactions made on behalf of customers.

Agency Transactions

Market making can involve either ________ or _______ transactions.

Agency or principal transactions.

With best efforts underwriting, investment bankers act as _________ of a fee basis related to their success in placing the issue with investors.

Agents

Wealthy individuals who make equity investments.

Angel Venture Capitalists (or Angels)

In ____________ transactions, the market maker seeks to profit on the price movements of securities and takes either long or short inventory positions for its own account.

Principal Transactions

A securities issue placed with one or a few large institutional investors.

Private Placement

Why are commercial banks also called depository institutions?

Because a significant portion of their funds come from customer deposits.

Why most banks hold such significant amounts of cash and investment securities?

Because of the extensive levels of deposits held by banks, they must be able to meet the demand from liability holders if and when they liquidate the claims they hold.

Why do banks tend to hold equity close to minimum levels set by regulators?

Because of the relatively low cost of deposit funding

Firms that assist in the trading of existing securities.

Broker-Dealers

Money market mutual funds sold by investment banks that offer check-writing privileges.

Cash Management Accounts

The largest (in dollar value of assets) FI group is _________.

Commercial Banks

By using ___________, a corporation can sidestep banks and the loan market to raise funds, often at rates below those banks charge.

Commercial Paper

_______: A short-term debt instrument issued by corporations either directly or via an underwriter it institutional investors in the financial markets, such as money market mutual funds.

Commercial Paper

_____: a bank that specializes in retail or consumer banking.

Community Bank

______: is the oldest U.S. bank regulatory agency.

Comptroller of the Currency (OCC)

__________: the provision of banking services to other banks that do not have the staff resources to perform the services themselves.

Correspondent Banking

Business entities whose sole purpose is to find and fund the most promising new firms.

Institutional Venture Capital Firms

What are the key exposure concerns for banks managers?

Interest rate risk --or maturity mismatch risk-- and liquidity risk

______: The difference between lending and deposit rates.

Interest rate spread

_______: involves managing pools of assets such as closed and open-end mutual funds.

Investing

____________: refers to activities related to underwriting and distributing new issues of debt and equity securities.

Investment Banking

What are some of the OBS activities?

Issuing various types of guarantees (such as letters of credit), which often have a strong insurance underwriting element, and making future commitments to lend.

Investment securities provide banks with ____.

Liquidity

Commercial banks and other financial institutions are exposed to high levels of _____.

Liquidity Risk

The risk that arises when a financial institution's liability holders such as depositors demand cash for the financial claims they hold with the financial institutions.

Liquidity Risk

__________: Mechanisms that FIs have used to hedge their credit risk exposure.

Loan sales and securitization

___________: the packaging and selling of loans and other assets backed by loans or other securities issued by the FI

Loan sales and securitization

What is the main revenue-generating asset for banks?

Loans

Classification as a money center bank is based in part on what?

Location of the bank and, in part, on the bank's heavy reliance on nondeposit or borrowed sources of funds.

The major assets of a commercial bank are _______ and their major liabilities are ______.

Major assets: Loans (financial assets) Liabilities: Deposits

________________: Involves the creation of a secondary market in an asset by a securities firm or investment bank.

Market Making

How can commercial banks produce new types of contracts such as long-term mortgage loans to households while still raising funds with short-term liability contracts such as deposits.

Maturity Mismatching

Some of the very biggest banks are often classified as being __________.

Money Center Banks

______: a bank that relies heavily on nondeposit or borrowed sources of funds.

Money center bank

As business loans have decreased, ________ have increased in importance.

Mortgage Loans

________: An interest-bearing checking account.

NOW account

__________: deposit claims with promised interest rates and fixed maturities of at least 14 days that can be resold to outside investors in an organized secondary market.

Negotiable Certificates of Deposit

_____: actual losses on loans and leases.

Net charge-offs

_____: Interest income minus interest expense divided by earning assets.

Net interest margin

Are issuers of privately placed securities required to register with the SEC?

No, since the placements are made only to large, sophisticated investors.

_______: Loans past due 90 days or more and loans that are not accruing interest because of problems of the borrower.

Noncurrent loans

_____: examines national banks and has the power to approve or disapprove their merger applications.

OCC

Why do only the largest banks offer trust services?

Only the largest banks have sufficient staff to offer trust services.

___________: involves purchases of large blocks of securities on the expectation of a favorable price move.

Position Trading

In firm commitment underwriting, the investment banker acts as a _______, purchasing the securities from the issuer at one price and seeking to place them with public investors at a slightly higher price.

Principal

Losses such as those due to defaults are charged off against the ____ in a bank.

The equity (stockholder's stake)

Although business loans were the major asset on bank balance sheets between 1965 and 1987, they have dropped in importance since 1987. Why?

The rise in nonbank loan substitues, especially commercial paper.

What is the major difference between banks and other firms?

Their high leverage or debt-to-asset ratio.

What is the primary function of the OCC?

To charter banks as well as to close them.

What is the role of investment securities for banks?

To generate interest income for the banks and are also used fro trading and liquidity management purposes.

_________: The sum of noninterest-bearing demand deposits and interest-bearing checking accounts.

Transaction accounts

True or False: Correspondent banking services are generally sold as a package or services.

True

True or False: Loan sales and securitization have allowed FI asset portfolios to become more liquid and have provided an important source of fee income.

True

True or False: Off-balance sheet activities are becoming increasingly important, in terms or their dollar value and the income they generate for banks.

True

______: Commercial-oriented banking, such as providing residential and consumer loans and accepting smaller deposits.

Wholesale Banking

Do NOW accounts have minimum balance requirements?

Yes

Are commercial banks regulated separately from savings institutions and credit unions?

Yes.

____: income before taxes and extraordinary items.

net operating income