Summary: Financial Markets And Institutions

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  • Lecture 1: Traditional Banking

    This is a preview. There are 21 more flashcards available for chapter 03/02/2015
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  • Financial institutions are divided into 2 groups

    1. Depository institutions (Commercial Banks, or CBs)
    2. Non-depository institutinos ( Venture capital, hedge funds, mutual funds etc.
  • What is the difference between FIs and Non FIs

    1. Financial intermediaries are highly leveraged 
    2. and hold large quantities of financial claims as assets
  • What role do Financial intermediaries take: What problem do they solve

    1. Information asymmetry pre-contract  --> leading to adverse selection and duplicated screening
    2. Information asymmetry post-contract ---> leading to moral hazard
  • What firms typically choose banks as a source of financing?

    • Middle aged firms with tangible assets
    • Able to offer collateral to mitigate moral hazard
    • Hanks loans of short matures --> diminishing total contracting costs
    • Albe to obtain a loan at a lower price
  • What choises of finance does a company have?

    • Venture Capital (young firms, no collateral, equity participation)
    • Bank (Middle aged, tangible assets, collateral)
    • Capital Market (Mature firms, credit history, borrowers incentive to limit risk taking, low cost direct acces capital markets)
  • Name the 3 dimensions under which there is a mismatch between the assets and the liabilities of a commercial bank

    1. Credit risk: banks claim against borrowers (Asset) is riskier than the depositors claim agains the bank (liabilities) --> hedge via CDS
    2. Interest risk: Assets have longer maturities than liabilities. --Hedge via interest rate swap
    3. Liquidity: Assets have lower liquidity: deposits are redeemable without notice. --> rely on the central bank for liquidity
  • Dealer banks are a key player in todays financial markets. What does a dealer bank do?

    The distinction between commercial banks and non-depository institutions is not always clear, especially the case for dealer banks:
    • Act as intermediaries in the market for securities
    • Conduct speculative trading
    • Is a prime broker to hedge funds
    • Conventional banking operations
    • Act as an investment bank
    • Operaties under the umbrella of holding companies (large complex financial institutions
  • Risks of a dealer bank failing:

    • signifiant stres on its counter-parties and clients, and on prices of assets and securities it holds
    • Reduces the ability of the financial system to absorb negative shocks
    • Creates systematic risk
  • What are the 3 Major risk a banks faces?

    1. Default / credit risk. The risk that a borrower does not make a contractual payment on time.
    2. Interest rate risk (risk due to mismatch of maturities of assets and liabilities)
    3. Liquidity Risk. Risk that depositors may withdraw funds
  • What are the two sources of default risk and how can a bank control for default risk?

    1. "physical" hazard: cash flow variation beyond borrowers control
    2. "moral hazard": borrowers incentive to take actions that increase the banks risk exposure

    • Screening
    • Monitoring
    • Collateral
    • Diversification

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