Chapter 3. Financial Instruments, Markets, and Institutions. Federal Reserve
affects the supply of money. Quantitative. 1. Open Market Operations. 2.
Reserves.
Chapter 3 Financial Instruments, Markets, and Institutions Federal Reserve affects the supply of money
Quantitative
1. Open Market Operations 2. Reserves 3. Discount Rate
affects aggregate levels of income, production, employment, price
Qualitative
1. Regulation Q 2. Margin Requirements 3. Moral Session 4. Min. Down Pmt.
affects ownership mix of money and credit, changes the distribution of spending and income among sectors of economy
Options to DSU/SSU DSU (Borrower)--Three Options: Reduce Dollar balances Dissave by selling financial securities they own Borrowing by issuing new financial securities on themselves SSU (Saver)--Three Options Build up their dollar balances Reduce their debt by buying back securities Lend by buying securities issued by DSU
Financial Markets:
Financial Institutions:
Allow for the exchange of financial assets such as stocks/bonds.
Facilitate flow of funds from individuals, corp's, or govt. from surplus spenders to deficits spenders
Financial/Real Sector Financial Asset Real Asset Primary Security:
Types of financial markets Broad Classifications: Money Market Lower return More liquid Capital Market Primary Market---- New issues Secondary Market—transfer of ownership provides for primary market: (1) information on pricing (2) liquidity
More Detailed Classifications: Stock Bond Mortgage Futures* Options* Spot Auctions Negotiations Organized Over-the-Counter *Derivative securities-- are financial securities whose values are derived from the values of underlying assets. Options:--Puts and calls Common Properties of derivatives: 1.Allow one to speculate on movements in underlying assets without the cost of purchasing the asset--high financial leverage 2.Can be used to hedge existing investments
Examples of Money Market Instruments: T-Bills Zero-coupon securities Traded on basis of yield not price Bid/Asked yields Book entry Sold on auction Competitive Stop-out price Noncompetitive Fed Funds Reserve balances Overnight Telephone trades Rate Commercial Paper Unsecured promissory note of large, natl known corporate firms Maturities < 270 days Min. denomination $25000 Credit Ratings Not registered with SEC Standby Line of Credit Some secured BA Draft on commercial bank, generally payable to the exporter, based on funds that will be deposited at the bank by the importer by the maturity date Acceptance Sell Keep Letter of Credit Fee Secondary market Retail CDs Time deposit NCDs Large time deposits Min. denomination $1 million Credit quality--issuing institution Term CDs Repos ST collateralized loans in which the borrower sells securities to the lender with a provision to repurchase them on a specified date at a specified price Reverse repos/matched-sale-purchase agreement Overnight to a few days Rate-below Fed Funds Trustee Eurodollar deposits Deposits at foreign offices of US or foreign banks denominated in dollars rather than the local currency Generally Time deposits
Examples of Capital Market Instruments Treasury notes & bonds Notes--original maturity 1-10 years Bonds-original maturity greater than 10 years Multiples of $1000 Auction Dutch Auction Book entry Strips Interest and principal separated Government Agency Govt Natl Mortg. Assoc Federal housing Authority (FHA) Export-Import Bank Government-Sponsored Agencies Fed Home Loan Banks Fed Home Loan Mortgage Commercial Federal Natl Mortgage Assoc (Fannie Mae) Farm Credit System Student Loan Marketing Assoc (Sallie Mae) Resolution Funding Corp (REFCO) Corporate bonds Fixed rate Maturity Special features Call Convertibility Collateral Ratings Foreign bonds Yankee bonds Eurodollar bonds Municipal bonds Issued by state and local government Coupon income exempt from federal income tax Often sold as serial bond Sold Competitive bid Negotiation Types GO Revenue Volatile market Mortgages Largest type of debt Mortgage types Securitization Pass-through Ginnie Mae Fannie Mae FHA VA CMO
Equity No maturity Residual claim on earnings and assets Types Preferred Common
Role of Financial Intermedaries 1. Transaction Costs ---reduce costs 2. Diversification 3. Production of information a. consumers & small businesses creditworthiness Stimulate Savings: Stimulate Borrowings: Types of Financial Intermediaries (Institutions) Depository Commercial Banks -Dually chartered -insured (FDIC) BIF A/L composition Major asset--Commercial loans Major liability-Time deposits Thrifts: Non-Bank Depository S/L's -dually chartered -insured SAIF -A/L Structure Major asset--residential mortg Major liability—Time deposits Credit Union fastest growing segment NCUSIF A/L Composition -Major Asset---Personal loans -Major liability—time deposits Mutual Savings Bank -New England -Only Sate Chartered -A/L Composition Major Asset--- Consumer loans & bond portfolio Major liability--Time Non-Depository Insurance Co. Law of large #'s Uninsurable risk Life Ins -Tax Code -Equities
-Managed Pension Funds -Organization A/L Composition Major Asset-LT taxable Corporate and mortgages Major liability—Insurance Reserve (Policies) Casualty Ins. -Certainty -A/L Composition Major Asset—Intermediate tax-exempt bonds Major liability—Insurance Reserve (Policies) Finance Co. Consumer finance Co's (Morris Plan banks) Sales Finance Co (GMAC) Bus. Finance Co. A/L Composition Major Asset—loans Major Liability—Commercial Paper & debt on themselves Investment Co. Types Open-end Co. Closed-end Fund Advantages Disadvantages Money Market Funds Pension Funds -Defined Benefit -Defined Contribution Major Types 403b 403k Problems Keogh Plans IRA's Private Pension Plans ERISA
