Financial Markets and Institutions Summary 4.2

FFINANCIAL MARKETS AND
INSTITUTIONS
Finance block 4.2



TABLE OF CONTENTS
Part 7: Nonbank Operations ..................................................................................................................................... 2
Chapter 22: Finance Company Operations ....................................................................................................... 2
Chapter 24: Securities Operations ...................................................................................................................... 6
Chapter 23: Mutual Fund Operations .............................................................................................................. 13
Chapter 25: Insurance and Pension Fund Operations ................................................................................... 21
Mishkin ...................................................................................................................................................................... 31
Chapter 18: The Foreign Exchange Market .................................................................................................... 31
Chapter 19: The International Financial System ............................................................................................. 41
Excercises: Chapter 18 and 19 ........................................................................................................................ 47
Allen ........................................................................................................................................................................... 48
Chapter 3: Operational Risk .............................................................................................................................. 48
Chapter 6: Managing Financial Risk................................................................................................................. 62
Chapter 7: VaR and Stress Testing ................................................................................................................... 62
Excercises: Chapter 3, 6 and 7 ........................................................................................................................ 76
Crowdfunding, Angel Investments and Islamic Banking ............................................................................ 77
Crowdfunding ...................................................................................................................................................... 77
Angel Investments .............................................................................................................................................. 80
Islamic Banking ................................................................................................................................................... 81
Mock Exam: Financial Markets and Institutions 4.2 .......................................................................................... 88




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,PART 7: NONBANK OPERATIONS




CHAPTER 22: FINANCE COMPANY OPERATIONS

Types of finance companies:
1. Consumer Finance Companies:
− Provide financing for customers of retail stores or wholesalers; (e..g., Walmart, Target)
− Provide personal loans directly to individuals to finance purchases of large household items;
(appliances, furniture)
− Provide mortgage loans.
2. Business Finance Companies:
− Offer loans to small businesses;
− Provide financing in the form of credit cards that are used by a business’s employees for travel
or for making purchases on behalf of the business.
3. Captive Finance Subsidiaries:
A wholly owned subsidiary whose primary purpose is to finance sales of the parent company’s
products and services, provide wholesale financing to distributors of the parent company’s products,
and purchase receivables of the parent company. (e.g., automotive companies)


Advantages of Captive Finance Subsidiaries:
− Can be used to finance distributor or dealer inventories until a sale occurs, making production less
cyclical for manufacturers;
− Can serve as an effective marketing tool by providing retail financing. It can also be used to finance
products leased to others;
− Allows a corporation to clearly separate its manufacturing and retailing activities from its financing
activities.




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,Sources of Funds:
− Loans from Banks: Finance companies borrow from commercial banks and can renew the loans over
time;
− Commercial Paper: Finance companies continually roll over their issues to create a permanent source
of funds;
− Deposits: Some states allow finance companies to attract funds by offering customer deposits;
− Bonds: Finance companies in need of long-term funds can issue bonds;
− Capital: Finance companies can build their capital base by retaining earnings or by issuing stock.


Uses of Finance Company Funds:
− Consumer Loans: Finance companies extend consumer loans in the form of personal loans;
− Business Loans and Leasing: In addition to consumer loans, finance companies also provide business
(commercial) loans;
− Real Estate Loans: Finance companies offer real estate loans in the form of mortgages on
commercial real estate and second mortgages on residential real estate;
− Summary of Uses of Funds: The uses of funds depends on whether the finance company is focused
on business or consumer lending.


How Finance Companies Finance Economic Growth:




Interaction with Other Financial Institutions:
− When finance companies obtain, or use funds, they interact with other financial institutions;
− Finance companies compete with commercial banks, savings institutions, and credit unions;
− Finance companies utilize various financial markets to manage their operations.


Interaction between finance companies and other financial institutions:




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, Participation of finance companies in financial markets:




Exposure of Finance Companies to Risk
Liquidity Risk Finance companies generally do not hold assets
that could be easily sold in the secondary market.
However, their balance sheet structure does not
call for much liquidity.
Interest Rate Risk Both liability and asset maturities of finance
companies are short or intermediate term.
Therefore, they are not as susceptible to
increasing interest rates as savings institutions are.
Credit Risk Credit risk is a major concern because the
majority of funds are allocated as loans to
consumers and businesses.


Valuation of a Finance Company:




Economic growth:
Economic growth: Can enhance a finance company’s cash flows by
increasing household demand for consumer loans,
thereby allowing the finance company to provide
more loans.


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