financial institutions exam 1

financial market

structures through which funds flow

2 major dimensions to distinguish financial markets

• primary vs secondary markets

• money vs capital markets

primary market

markets in which users of funds raise funds through new issues of financial instruments such stocks and bonds. includes IPO’s

secondary markets

markets that trade financial instruments once they are issued

money markets

trade debt securities or instruments with maturities of one year or less. safe and liquid

capital markets

trade debt and equity instruments with maturities of more than one year. higher risk and debt

foreign exchange risk

sensitivity of the value of cash flows on foreign investments to changes in the foreign currency’s price in terms of dollars

derivative security markets

a financial security such as future, option or MBS whose payoff is linked to another, previously issued security, such as security traded in capital or foreign exchange markets

financial instruments

subject to regulations imposed by regulatory agencies, such as the SEC

Financial Institutions act as ________

asset transformers

enterprise risk management

managing risk in an interrelated risk portflio

Fintech

use of technology to deliver financial solutions in a manner that competes with traditional financial methods

required rate of return

minimal acceptable return on stock

expected rate of return

what return you think is feasible

realized rate of return

what return you actually get

durations and coupon interest

the higher the coupon or promised interest payment on the bond, the shorter the duration

duration and maturity

duration increases with maturity, but at a decreasing rate

duration

average life of a bond, direct measure of its price sensitivity to changes in interest rates

1. reserve ratio

a bank can loan out 90% of the reserves they have

depository

Institutions that accept money from the public and provide loans or other financial services using those funds

non depository

Institutions that provide financial services but do not accept deposits from the public

duration

a measure of the sensitivity of a bond’s (or fixed-income security’s) price to changes in interest rates.

determinants of bond interest rate risk

• time to maturity (the longer it is, the higher the interest rate risk)

• coupon rate (the higher it is, the lower the interest rate risk)

federal reserve

• conducts monetary policy

• maintain financial system stability

dual mandates of the federal reserve

1. promote maximum employment

2. promote stable prices

Federal Reserve System (FRS)

divided into 12 federal reserve districts, each with its main federal reserve bank

Money Market Securities

1. treasury bills

2. federal funds

3. repurchase agreements

4. commercial paper

5. negotiable certificates of deposit

6. bankers acceptance

1. treasury bills

short term debt obligations issued by the government to cover budget deficits

treasury bill auction

formal process with which the government sells new issues of treasury bills

2. federal funds

short term funds transferred between financial institutions, usually for a period of one day

fed funds rate

interest rate for borrowing fed funds

3. repurchase agreement

an agreement involving the sale of securities by one party to another with a promise to repurchase at a specific date and price

reverse repurchase agreement

the purchase of securities by one party from another with the promise to sell them back

4. commercial paper

unsecured short term promissory note issues by a company to raise short-term cash

5. negotiable certificates of deposits

bank-issued, fixed maturity, interest-bearing time deposit that specifies an interest rate and maturity date and is negotiable

6. bankers acceptance

time draft payable to a seller of goods, with payment guaranteed by a bank

Asset Backed Commercial Paper

short term debt, backed by a pool of assets that helps investors trust the company

computing Present Value

pv=?

fv= par value

pmt= coupon rate *par value

N= years to maturity

i= current yield

% change in bond price

new price- old price/ old price

duration solving steps

1. years

2. cash flows (coupon * 1000)

3. discount CF (1/(1.05^t))

4. denominator (CF*discount CF)

5. numerator (denominator * t)

For the purposes for which they are used, money market securities should have which of the following characteristics?

1. low trading costs

2. little price risk

the most liquid of the money market securities are

treasury bills

money market securities exhibit

1. large denomination

2. low default risk

3. contractually determined cash flows

A short-term unsecured promissory note issued by a company is

commercial paper

three monetary policy tools

1. reserve ratio

2. discount window

3. open market operations

2. discount window

The interest rate at which commercial banks can borrow short-term funds directly from the central bank

3. open market operations

Buying and selling government securities (like Treasury bills) in the open market.

definition of NAV

dollar value of one mutual funds share

• does not speak to performance

Exp Ratio

given as percentage, multiply by how much you invest in it and that is your cost

• cost created by investors who own mutual funds

“Interpret Portfolio Net Assets”

difference between portfolios total assets and liabilities

in open market operations, if Fed purchases securities from primary dealers,

a. it will CREDIT dealers reserve accounts

b. credit availability will go up

which of the following is used in discounting cash flow for securities PV

required rate of return

the higher the coupon rate…

the lower the interest rate risk sensitivity

the higher the maturity…

the higher the sensitivity to rate

All else equal, bonds with longer durations have…

higher interest rate risk

If the fed cuts rates…

a. unemployment goes down

b. inflation goes up

what is the impact of “doubts about the feds credibility” on global capital flows to the U.S.

less investments coming in from foreign countries

what is the impact of “doubts about the feds credibility” on the value of U.S. dollars

lowers credibility, weakens our dollar