FIN 301 Chapter 8

How do stock picks of analysts' stock picks perform?

Averaged, they were outperformed by the S&P 500. This is because markets are relatively price efficient

Hedge Funds

A private partnership that uses advanced investment strategies to generate high returns for wealthy investors and institutions.
-Strategy is critical but very few actually hedge
-There have been great successes but also many catastrophes -- ----LTCM and P

Elements of hedge funds

Lax Regulation
Exclusivity
Illiquidity

Lax Regulation

Largely unregulated
Cater only to large, sophisticated, and accredited investors

Exclusivity

Minimum investment is usually in the millions of dollars
Must have some sort of positive investment history

Illiquidity

Usually require investors to hold money in the fund for at least one year
Less liquid that mutual funds and more liquid than private equity

2 and 20 Fee Structurs

2% charged on assets under management
20% charged on performance
-If you have special skills in investment, the way to get rich is through hedge funds
-Hedge fund managers are rewarded for good performance
-Fees much higher than mutual funds
-Mutual funds

High water mark

If a fund has losses, managers don't get paid performance fees until losses are recovered

Hedge fund blow-ups

Long-Term capital management
Bernie Madoff and other Ponzi Schemes

Forms of financial institutions

Denomination
Liquidity and maturity
Default risk/diversification
Economies of scale in information and transactions costs
Investment expertise

Commercial banks as financial intermediaries

-Intermediate between companies and investors
-Put your money in the bank, they turn it around and return it a higher rate
a. They take our small amounts of moneys and take out large loans
b. Lend their money at a higher rate than they pay us to take the

Mutual and Hedge Funds as Financial Intermediaries

-We buy shares in a hedge fund or mutual fund and they turn it around and invest it
-They sell on the idea that they have investment expertise

The Glass-Steagall Act

-Passed after Great Depression to re-establish trust and credibility on Wall Street
-Forced separation of commercial and investment banking activities
-Financial services Modernization Act of 1999
a. Eliminated separation of banks, securities firms, and i

What is true about financial institutions?

Banks primarily take deposits and make loans

Sell side

-Create, make markets, and sell financial products
-Investment banks and Commercial banks
a. Banks take deposits and make loans at a high rate
b. Investment banks issue debt and buy HIGHER YIELDING SECURITIES

Buy side

-Buy, hold, and trade financial products
-Commercial banks, mutual funds, money managers, insurance companies, hedge funds, and financial entities
a. Insurance companies hold reserves and invest in bonds
b. Investment companies hold shares and make invest

Investment companies, asset managers, and mutual/pension funds

Assets under management

What are assets under management

Increases revenue, directly linked to market valuations, major fall in asset prices causes a decline in revenues, alternative asset management -- professionals can get away with the SEC

Insurance Companies

-Collect fees for providing insurance, earn returns on their own portfolios.
-Life, property, and casualty health, special needs
-Revenues: Premiums, investment income
-Expenses: Claims, admin.

Money center banks (commercial banks)

-Net interest income: Interest Revenue - Net Interest Expense = NI
-Shape and steepness of the yield curve is the major determinant of banks' lending margins
-Net interest margin: The difference between the "borrowing" rates and the "lending rates

People don't want t put all of their money into one account

Depository institutions
Investment co. Asset Managers, Mutual/Pension funds
Investment Banks & Brokerages
Insurance Companies

Financial institutions were at the center of the financial crisi

1. Aggressive lending and investing strategies put financial system at risk
2. Bail out of system by federal government and federal reserve
3. Changed landscape for financial institutions
4. Old model of investment banks
a. Broker Dealers: Pure-play inves

Role in financial Crisis

1. Excessive risk taking
2. Lack of risk management
3. Lack of regulation
4. Compensation
5. Securitization and lack of financial transparency
-Investors in securitized securities did not know what they were buying
6. Ownership structure

Dodd-Frank Wall Street Reform and Consumer Protection Act

1. Created a council of regulators led by the treasury secretary
2. Ending too big to fail
3. Volcker rule
4. Consumer financial protection bureau

Council of regulators led by the Treasury Secretary (Dodd-Frank act)

1. Oversee the financial industry and identify threats to the system
2. Will review bank and non-bank companies to determine their stability
3. Decide if a company is endangering the system and can dismantle and sell off the company

Ending too big to fail (part of the Dodd-Frank act)

Limits the creation of large financial institutions and ends taxpayer funded bailouts

Volcker Rule (Dodd-Frank act)

Prevents banks from engaging in proprietary trading limits investment in hedge funds
a. Restrict risk taking by banks
b. Bans banks' proprietary trading and restricts investment in hedge funds
c. Large regulatory and compliance costs for banks

Consumer Financial Protection Bureau (Dodd-Frank act)

Attempt to eliminate deceptive techniques

Current issues

1. The regulations that develop for the Dodd-Frank Act
-Treated as a joke, will not protect common investors
2. Regulatory Dialect
-Regulations - Innovation - Crisis - Reregulation
3. Banks vs. Non-Banks
- The competition between the banks and the "non-ba