Financial Intermidiaries

Topics: Central bank, Monetary policy, Federal Reserve System Pages: 9 (1056 words) Published: July 20, 2013
FINTMED CLASSROOM NOTES

FINANCIAL INTERMEDIARY
* a middleman between people who needs capital and people who has capital * Institutions that matches lenders and borrowers

TOPICS: (for the whole term)
OVERVIEW| INTEREST RATES|
BANKS| COLLATERAL AND CREDIT RISK MANAGEMENT|
NON-DEPOSITORY FINANCIAL INSTITUTION| BANK CAPITAL AND DEPOSIT INSURANCE| * Insurance firms| BANK RUNS AND CONTAGIONS|
* Securities firms| BOND MARKETS|
* Investment firms| EQUITY MARKETS|
* Mutual funds| FOREIGN EXCHANGE MARKETS|
* Finance companies| DERIVATIVES|
* Private equity|
* Venture companies|
* Hedge funds|
* Angels|

FRACTIONAL RESERVE BANKING
* A form of banking where banks maintain reserves (of cash and coin deposits at the central bank) that are only a fraction of the customer’s deposits. * Deposited funds are mostly lent out, and a bank keeps only a fraction (called reserve ratio) of the quantity of deposits as reserves. Some of the funds lent out are subsequently deposited with another bank, increasing deposits at that second bank and allowing further lending, and so on…

Cash: 1125| 1125 GP|
Loan: 1125 375| 1500 GP Demand Deposits| Loan: 1500 375| 2000 GP|
| 1000 GP|
3400| 3400|

MONEY
* A promise to pay
* A claim to goods and services

BANK NOTES
* Another name for “cash”
* A negotiable promissory note issued by a bank and payable to the bearer on demand REVENUE| 150|
* Apple grower| 100|
Subtotal| 50|
Operating Expenses| |
* Salaries| 10|
* Search Cost| 5|
* Miscellaneous| 1|
SUBTOTAL| 34|
* Tax (30%)| 23.8|
NET INCOME| 10.2|

* Faith is important in a banking system.

FINANCIAL INTERMEDIARIES
* Broker – brings the buyers and sellers together
* Asset Transformer – carries financial risk on their balance sheet while brokers avoid carrying financial risk (e.g. banks, credit unions) DD
GP
NOTES PAYABLE
SAVERS
CONSUMERS OF CAPITAL

SOMETIMES, there are barriers to entry.
DD
LOAN (large, longer)
SAVERS
ASSET TRANSFORMER
BROKERAGE
CONSUMERS OF CAPITAL

* CONSUMERS OF CAPITAL issues PRIMARY SECURITIES (Debt and Equity – large in denomination) FINANCIAL INSTITUTIONS (SPECIAL):
1. Information Cost – delegated monitoring
2. Liquidity and Price Risk
3. Transaction Cost Services
4. Maturity Intermediation
5. Transmission of the Money Supply
6. Credit Allocation
7. *Intergenerational Wealth Transfer
8. *Payment Services
9. *Denomination Intermediation

DEMAND DEPOSITS (DD) – almost 100% guaranteed principal

* It is cheaper to buy securities in bulk than buy them individually.

CREDIT DEFAULT SWAP (credit derivative contract) – a swap designed to transfer the credit exposure of fixed income products between parties. Also referred to as a credit derivative contract, the purchaser of the swap makes payments up until the maturity date of a contract. Payments are made to the seller of the swap. In return, the seller agrees to pay debt off to a third party if this party defaults on the loan. CDS is considered an insurance against non-payment. A buyer of a CDS might be speculating on the possibility that the third party will indeed default (source: INVESTOPEDIA).

Kinds of Assets:
1. Physical Assets – assets such as property, plant, and equipment 2. Financial Assets – represents the claim on available goods/services in an economy 3. Derivatives (Derivative Instruments0 – a contract between two parties that specifies conditions (dates, resulting values of underlying variables, notional accounts) under which payments are to be made between parties

Kinds of Money
1. Outside Money (bank notes)
2. Inside Money (demand deposit accounts)

How Federal Reserve Banks guide Monetary Policy (from frbsf.org):...
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