As per your request, answers to problems from chapter 13.
- FIs provide services that help reduce the risks and costs associated with borrowing, lending, and their financial transactions. FIs also help fulfill the demand for various Financial assets and services, including protection against the financial losses associated with various exigencies.
FIs provide these services because they are profit-seeking Firms.
- A contingent Financial claim is a claim such as casualty and life insurance benefits that offer the public protection from the often-catastrophic Financial effects of theft, accidents, natural disasters, and death.
- Financial intermediation helps reduce the risks associated with lending and borrowing money. Given the relative safety that FIs offer, SSUs don’t have to give up as much safety for higher returns, and in turn, the reduction in risks will afford lower rates for DSUs.
- FIs are like other firms in that they too are profit seeking. Also, FIs are Firms producing services just as nonfinancial firms in the economy produce goods.
FIs are similar in that they are profit-seeking firms that link up DSUs and SSUs and in the process, provide the public with a wide range of financial services.
The differences among FIs manifest themselves in the financial services they specialize in and the composition of their balance sheets.
- If a FI has mainly long-term liabilities with few payment uncertainties, it will most likely invest in longer-term assets or financial investments. Longer-term instruments generally provide higher yields than shorter-term assets but are not as liquid. Given the nature of FIs with mainly long-term liabilities and few payment uncertainties, holding large portions of liquid assets is not as essential as it is for banks.
- Depository institutions are intermediaries and include commercial banks, S & Ls, saving banks, and credit unions that issue checkable deposits and get a large portion of their liabilities from deposits.
- Banks hold reserve assets because the Fed requires them to hold these assets. Further, banks hold reserve assets to meet their liquidity and safety objectives.
- Contractual-type intermediaries, such as life insurance companies, casualty companies, and pension funds, offer contingency claims in return for regular payments.
- Finance-company-type FIs major sources of funds come from selling commercial paper, issuing long-term bonds, and obtaining bank loans. This type of FI lends funds to households to finance the purchase of automobiles, appliances, and furniture.
- Senior Life Insurance Co. needs to hold less liquid assets than A-I Student Auto Insurance Co. because they (Senior Life Insurance Co.) can fairly well predict the factors which determines the payments they have to pay to policy holders.
Depository Institutions mange their liquidity risk by holding highly liquid assets and by having back up lines of credit.
- John can obtain a mortgage loan from commercial banks, savings associations, credit unions, life insurance companies, private pension funds, and finance companies.
- Money market mutual funds are funds that invest in money market instruments. They are similar to depository institutions in that in the early 1990s, depositors started to deposit their money into these funds just as they do in banks.
- Casualty companies would hold municipal securities in their portfolio of assets because they are taxed at a full 35% corporate rate and municipals are exempt from federal taxation.
Credit unions and life insurance companies would not hold municipal securities in their portfolios. Credit unions and life insurance companies are not taxed as high percentage as casualty companies.
- The major determinants of an FI’s liability structure are the range of financial services offered and any specialization in particular service.
- Diversification will help cover the losses of some investments with the profits of other loans and investments.
In the event of widespread economic collapse, diversification will not always reduce the risk.
- As a result of the "Savings and Loan Crisis or Debacle," the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) was implemented in 1989. The act attempted to resolve the S & L crisis by creating a new regulatory structure, limiting the assets S & Ls could acquire, and requiring S & Ls to maintain adequate capital.
- Depository institutions have deposit insurance.
- The original savings banks were "mutual," which meant that the depositors were really the owners of the institutions. They were actually benevolent philanthropic institutions set up to encourage the poor and the working class to save to relieve poverty and pauperism.
- If a bank has assets of $100 million and liabilities of $95 million, its net worth is $5 million. If 60% of its assets are loans, 8.33% of its loans could go sour before it loses all of its capital.
- Exhibits throughout the chapter illustrate the major sources of funds and major uses of funds for the various depository institutions.
- A. Liquidity risk