FIN MKT & INSTITUT
FIN MKT & INSTITUT FIN 4319
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This 2 page Class Notes was uploaded by Corine Gibson on Wednesday September 23, 2015. The Class Notes belongs to FIN 4319 at Texas State University taught by H. Toles in Fall. Since its upload, it has received 32 views. For similar materials see /class/212742/fin-4319-texas-state-university in Finance at Texas State University.
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Date Created: 09/23/15
m savings exceeds investment in real assets m savings is less than investment in real assets saver can be a DSU Broker matches buyers amp sellers charges a commission financial middleman NOT intermediary Dealer market maker willing to buysell at bidask spread Investment banker primary market dealer M income is greater than consumption Financial asset IOU claim on another economic unit promise to pay Indirect lending occurs through financial intermediaries ie insurance co commercial bank mutual fund Secondary markets increase the supply of loanable funds trading after issuance supply shifts right interest rates drop increase in quantity invested and liquidity Services of Financial Intermediaries Denomination divisibility facilitates operational efficiency Liquidity interm ediation risk Maturity intermediation Economies of Scale information production transaction cost Diversification Record keepingPaym ent processing Risk managem ent QEJ HeP NE Disintermediation pulling money out of intermediary to invest directly Crossintermediation pulling money out of one intermediary to put into another ie bank to mutual fund Avg rate of time preference increases increase in current consumption amp interest rates amt invested decreases 2 closed economies A has higher rate of time preference A will have higher interest rate and higher level of consumption B will have lower interest rate and higher level of investment if economies open B would want to invest in A Time preference amp investment opportunity are 2 factors that determine whether economic unit would be a DSU instead of an SSU SSUstrong investment opportunity The net worth of the aggregate economy the value of real assets Tbills have lower quoted yields than commercial paper because commercial paper is less liquid and has credit risk Both are quoted on a bank discount basis In 2006 the largest SSU was the rest of the world amp the largest DSU was the household sector In 2008 the household sector was the largest SSU it it 7 gt a An individual can save their savings by investing in real amp financial assets amp paying off financial liabilities In the aggregate economy savings investment in real assets A principal economic function of a financial market is to transfer funds from those who have surplus savings to those who need funds to invest in real assets A commercial bank is a financial intermediary A broker is not A decrease in the average rate of time preference would cause interest rates to decrease amp amount of savings and investment to increase The maximum that a firm will invest depends on the rate of interest which is the cost of loans the firm will invest only as long as the marginal productivity of capital exceeds or equals the rate of interest Firms will reject only projects whose gain is not more than their cost of financing The firm s demand for borrowing is negatively related to the interest rate39 id the rate is high only limited borrowing amp investment make sense At a low rate of interest more projects offer a profit and the firm wants to borrow more39 this negative relationship exists for each and all firms in the economy global savings glut pushed asset prices up amp marginal return on productive capital down If global market rate of interest decreases the effect on an individual DSU country would be a decrease in domestic savings increase in domestic capital investment amp increase in borrowing from the rest of the world Interest earned from investing in Tbills is exempt from state amp local income taxes Commercial paper is an unsecured obligation of a corporation country would be a net borrower if it had a relatively high rate of time preference amp a relatively high rate of return available on domestic real investments Bernanke said the US is such a large DSU because of an excess of domestic investment over domestic savings A newly issued Tbill is a couponbearing security The yields on Eurodollar CD s are higher than yields on domestic CD s because banks avoid reserve requirements when issuing Eurodollar CD s banks avoid paying Federal Deposit insurance premiums on Eurodollar CD s amp yield on EDCD s re ect a sovereign risk premium Invest in bond with higher EAR l YTMmm l where m 2 for semi 4 for quarterly 12 for monthly Discount Basis Tbills and Commercial Pa er Price 100P interest rate100 of days360 BEY 100P x E P n EAY 1 looP365quot 1 P Money Market Basis CD s and Eurodollars BEY interest rate365360 Req return risk free rate market rate 7 risk free ratebeta Value current dividend l growth rate Required return 7 growth rate Bonds are normally around 30 years longterm Notes are like bonds but different timematurity 2 3 5 10 yrs not a money market security due to price risk Bills do not pay coupons and have a maturity of one year or less Municipal bonds are tax exempt unlike corporate bonds Money Market market for cash equivalents vs Capital Market ability to convert Bonds cash quickly maturity one year or less Equity minimal risk or oss Hybrids minimal default risk Deriv atives minimal tradingtransaction costs Mortgages minimal price risk Interest rate determinants 1 Average marginal rate of time preference more inclined to consumed today higher 2 Marginal return on productive capital Difference in interest rates Differences in 1 Liquidity risk 2 Maturity 3 Default risk 4 Taxability 5 Embedded options callput features convertibles 6 urrency Investment forego current consumption in return for greater expected future consumption Savings income minus consumption net worth real assests financial assets 7 financial liabilities Dealers make money on the spread on the carry amp speculate A bond that pays coupon payments more often should have a higher yield and vice versa Price par C Y Price gt par C gt Y Price lt par C lt Y Fisher s Theory of Interest rate of time preference return on productive capital real assets Fisher s Separation Theorum Principle of Unanim it decision to consume amp save is separate from that of investing Overestimate IOCMistakes too much borrowing and lending too much current consumption illusion of current wealth too much investment Real asset provides benefits to owner based on intrinsic value Role of financial assets transfer funds to redistribute unavoidable risk associated with cash flows generated by tangible assets among those seeking and providing funds Integration of Financial Markets deregulation or liberalization advances in telecommunication or computer technologies institutionalization Only selling financial advice does not mean financial intermediary Asset mgt firms charge fee of the percent of assets under mgt A hedge fund would be structured as a limited partnership Functions performed by investment bankers advise issuer on terms and timing buy securities from issuer underwriting distribute issue to investors Underwriting acts as a dealer best efforts is more like a broker where there is no guarantee Bought deal one investment bank does the entire deal Private placement can structure terms of loan to fit borrower does not have to file with SEC can only market to qualified investors Rule 144A waives 2 year lack period market is more liquid investors are more willing to invest Reason for many brokers and few dealers in real estate brokers only match buyers amp sellers dealers must maintain inventory and may get stuck trading property If government put tax on buying stock prices would fall due to less trading and less liquidity 3 major investors in municipal securities are individuals primary banks and property casualtyinsurance co If marginal tax rates increased prices on municipal bonds would increase and yields would decrease 2 forms of credit risk are default risk and credit spread risk CD has a higher yield than Tbill due to it being quoted on the money market basis default risk less liquidity amp no tax advantage Serial bond specified principal amount due on specified dates Mortgage bond grants bondholders a lien against pledged assets
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