Part 1: Financial Institutions

Chapters 1, 2 and 3.

What are the functions of a financial system?

Mobilisation and allocation of savings, facilitating payments, providing liquidity, inter-temporal consumption and investments, managing risk, financial stability, price discovery.

What are the 4 essential concepts in finance?

Risk and reward, supply and demand, no arbitrage, time value of money.

What are the different types of financial institutions?

Depository institutions, contractual savings institutions, investment banks, finance companies and unit trusts.

What is a depository institution? Give 2 examples

an institution which accepts deposits and offers loans. E.g. banks and credit unions.

What is a financial system?

Compromises of financial institutions, instruments and markets which facilitates transactions for goods, services and assets.

What is a contractual savings institution? Name the 2 examples.

Collects funds through contracts and provides payments upon certain future events such as retirement or death. Superannuation funds and insurance/pension companies.

What is an investment bank?

An investment bank provides advisory services e.g. mergers and acquisitions.

What is a finance company?

Issues debt instruments and offer loans and leases.

What is an unit trust?

Pools investor funds and invest in specific asset classes such as property.

What is an investment bank?

An investment bank provides innovative financial products and services to corporations, high-net-worth individuals and government

Categorise the activities of investment banks and describe.

The activities of investment banks can be categorised as front-office, middle-office and back office.

Front office: E.g. investment banking, trading, research and investment management.

Middle-office: E.g. risk measurement, risk management and reporting.

Back-office: E.g. Accounting, bookkeeping, audit and compliance,

What are the sources of funds of investment banks?

Investment banks do not have a depository base, instead they raise funds through issuing securities in the international money and capital markets.

Do investment banks provide loans?

Investment banks may provide short-term loans to limited clients. However, their primary focus is on advisory services.

Where is the principal income of investment banks generated from?

Off-balance-sheet business.

What are the off-sheet-balance business activities of investment banks?

• Identifying risk and risk management.

• Operating as foreign exchange dealers.

• Acting as underwriters of new share and debt issues.

• Advising on mergers and acquisitions.

• The placement of new issues with institutional investors.

• Advising on and partial provision of venture capital.

• advising clients on raising funds in the domestic and international money markets.

• Advising corporate clients on structuring and restructuring their balance sheets.

• Conducting feasibility tests and advising on project and structure financing.

Define merger and acquisition

When a company takes over another company.

Define ‘spin-offs’

A spin-off is when a company breaks into pieces and those pieces become separate public listed companies.

What happens if there are no suitable buyers for the division in a spin off?

If there are no suitable buyers, the company spins off the division into two separate entities - parent and child.

What are mergers, acquisitions and spin-offs an example of?

They are an example of balance-sheet restructuring facilitation by investment banks.

What are the categories of mergers and acquisitions?

Horizontal takeover, vertical takeover and conglomerate takeover.

What is horizontal takeover? Give an example.

Horizontal takeover is when a company takes over another company which operates in the same type of business. Such as a shoe manufacturing company merging with another shoe manufacturing company.

What is a vertical takeover?

A vertical takeover is when a company takes over another company which operates in a related business usually within the supply chain. For example, a shoe manufacturing company merging with a shoebox manufacturing company.

What is a conglomerate takeover?

A conglomerate takeover is when a company diversifies its business activities by taking over a company in an unrelated business. For example, a shoe company merging with a condiments manufacturing company.

What is a hostile takeover?

A hostile takeover occurs when the board of directors of the target company actively resists the takeover.

Explain what is expected in terms of value regarding mergers and acquisitions.

The value of the merged company should be greater than the sum of the two companies standalone.

What are some synergy benefits of a merger and acquisition?

• Economies of scale - operating advantages by lowering the cost of production through better productivity.

• Competitive growth advantage - the company may gain immediate growth by acquiring existing business operations.

• Business diversification - may gain access to international markets by acquiring another company or diversity business activities through conglomerate takeover which can hedge the company against downturns in a single economic market.

• Finance advantages - better leverage due to a larger balance sheet - increased borrowing power.

List 8 ways an investment bank may assist with a merger and acquisition

• Analysis of the target company.

• Valuation of the company.

• Transaction structures.

• Negotiation.

• Due diligence.

• Establishing contacts.

• Project management and integration.

• Communication with the market.