An attempt to lower production costs by offering multiple services using the same facilities and resources is called
economies of scope
The best-known and often the most profitable investment banking service is
security underwriting
One of the most profitable underwriting services
Initial public offerings
private partnerships that sell shares to only a limited group of investors in order to invest in a wide variety of assets and derivative instruments in the hope of achieving exceptional returns regardless of the direction the market subsequently moves
- i
hedge funds
What act allowed the full range of investment banking services to open up for adequately capitalized and well-managed commercial banking firms?
It also allowed financial service companies to share customer information
Gramm-Leach-Bliley Act
Are investment banking revenue and profitability correlated with commercial banking revenues and profitability
yes. positively, but not highly
What do observes anticipate more of in the investment banking industry?
more mergers
#NAME?
Mutual fund investment products
What happens of a mutual fund is liquidated?
each investor receives a portion of the net asset value of the fund after its liabilities are paid off, based on the number of shares each investor holds
hedge against living too long and outlasting one's savings
Annuity investment products
promise a customer who contributes a lump sum of savings a fixed rate of return over the life of the annuity contract
fixed annuities
allow investors to invest a lump sum of money in a basket of stocks, mutual funds, or other investments under a tax-deferred agreement , but there may be no promise of a guaranteed rate of return
Variable annuities
What are the advantages and disadvantages of financial firms/depository institutions selling annuity products?
Advantage: annuities often carry substantial annual fees
Disadvantage: they typically compete with selling deposits
Current U.S. regulations require that customers must be told orally that investment products are:
1. Not insured by the Federal Deposit Insurance Corporation
2. Not a deposit or other obligation of a depository institution and not guaranteed by the offering institution
3. Subject to investment risks, including possible loss of principal
The management of property owned by customers, such as securities, land, buildings, and other assets
Trust services
Deposits placed in a bank by a trust department must be ______
fully secured
Popular kinds of trusts (5)
#NAME?
What is critical to trust services
the establishment of a fiduciary relationship
Potential benefits from offering multiple services include
economies of scale and economies of scope
Refers to a situation in which the joint costs of producing two or more services in one firm are less than the combined cost of producing each of these services through separate firms
economies of scope
Key items that must be included in a financial firm's privacy policy and be sent to its customers at least once a year
- the kinds of information about customers the financial firm may share with other firms
- the kinds of companies the customer's private information may be shared with
- what the customer can do to "opt out" of information sharing and tell the financial f
What is capital?
funds contributed by the owners of a financial instiution
Why is capital so important in financial-services management?
it provides a cushion of protection against risk and promotes public confidence
What tasks does capital perform?
1. promotes a cushion against the risk of failure
2. provides funds to help institutions get started
3. promotes public confidence
4. provides funds for growth
5. regulator of growth
6. regulatory tool to limit risk exposure
What are the types of capital in use?
1. Common stock
2. Preferred stock
3. Surplus
4. Undivided profits
5. Equity reserves
6. Subordinated debentures
7. Minority interest in consolidated subsidiaries
8. equity commitment notes
What are the four main capital components?
common stock, preferred stock, surplus, undivided profits
debt that looks and is treated like capital
subordinated debentures
Reasons for capital regulation
#NAME?
an international agreement on new capital standards
The Basel Agreement
What does the Basel Agreement do?
- designed to keep their capital positions strong
- reduce inequalities in capital requirements among different countries
- promote fair competition
- catch up with recent changes in financial services and financial innovation (in particular, the expansio
Two tiers of capital?
Tier 1 (core) capital
Tier 2 (supplemental) capital
Examples of tier 1 capital
common stock and surplus, undivided profits (retained earnings), qualifying noncumulative perpetual preferred stock, minority interest in the equity accounts of consolidated subsidiaries
Examples of tier 2 capital
allowance (reserves) for loan and lease losses, subordinated debt capital instruments, mandatory convertible debt, intermediate-term preferred stock, cumulative perpetual preferred stock with unpaid dividends, and equity notes and other long-term capital
In order for a bank to qualify as adequately capitalized, it must have
1. a ratio of core capital (tier 1) to total risk-weighted assets of at least 4%
2. a ratio of total capital (the sum of Tier 1 and Tier 2 capital) to total risk-weighted assets of at least 8 percent, with the amount of Tier 2 capital limited to 100 perce
How do you calculate risk-weighted assets?
1. compute the credit-equivalent amount of each off-balance sheet item
2. Multiply each balance sheet item and the credit-equivalent amount of each OBS item by its risk weight
0% risk weighted Category
cash and U.S. treasury securities
20% risk weighted Category
deposits at domestic banks, credit-equivalent amounts of SLCs backing municipal bonds
50% risk weighted Category
Mortgage loans secured by first liens on 1-to-4-family residential properties
100% risk weighted Category
loans to private corporations, cred-equivalent amounts of long-term unused loan commitments to private corporations, total risk-weighted assets held by this bank
Tier one risk based capital ratio
tier 1 capital/ total risk weighted assets
total risk-based capital ratio
(tier 1 capital + tier 2 capital)/ total risk weighted assets
A statistical framework for measuring a bank portfolio's exposure to changes in market prices or market rates over a given time period, subject to a given probabilty
Value at Risk (VaR) Models Responding to Market Risk
How do firms raise capital externally
1. Selling common stock
2. Selling preferred stock
3. Issuing debt capital
4. Selling assets
5. Leasing facilities
6. Swapping stock for debt securities
The principal reason many financial firms are issued charters of incorporation by state and national governments is to
make loans
What do loans do within the lender's market area?
support the growth of new businesses and jobs
What is the reason for taking capital?
if the borrower cannot pay, the pledge of collateral gives the lender the right to seize and sell those assets
What are the different types of collateral
accounts receivables, factoring, inventory, real property, personal property, personal guarantees
What are the two loan documents?
the promissory note, and the loan commitment agreement
What are the different types of loan covenants?
affirmative and negative
5 principals of loan review
1. carrying out reviews of all types of loans on a periodic basis
2. structuring the loan review process
3. reviewing largest loans most frequently
4. conducting more frequent reviews of troubled loans
5. accelerating the loan review schedule if economy o
Describe what structuring the loan review process entails
- record of borrower payments
- quality and condition of collateral
- completeness of loan documents
- evaluation of borrower's financial condition
- assessment as to whether the loan fits with the lender's loan policies
the process of recovering funds from a problem loan situation
loan workout
consumer loans are classified by
purpose and type
what is the purpose of a consumer loan?
what the borrowed funds will be used for
what does the type of loan tell you?
whether the borrower must repay in installments or repay in one lump sum
- credit to finance the purchase of a home or fund improvements on a private residence
- usually a long-term loan, typically bearing a term of 15 to 30 years
- secured by the property itself
- may carry either a fixed interest rate or a variable (floating
Residential loans
used to buy big-ticket items or to consolidate existing household debts
nonresidential loans
#NAME?
credit card loans and revolving credit
approximately two-thirds of all credit cards have _________ rates of interest
variable
credit cards are profitable due to the ___________________ they generate
interest income
Where is the Consumer Financial Protection Bureau supposed to be housed and why is it controversial?
#NAME?
Why are consumer loans priced so high?
so that market interest rates on borrowed funds and default rates on the loans themselves would have to rise substantially before consumer credits would become unprofitable
characteristics of consumer loans
#NAME?
What do FICO scores range from?
300-850 with higher values denoting less risk
What 5 types of information are FICO scores based on?
1. the borrower's payment history
2. the amount of money owed
3. the length of a prospective borrower's credit history
4. the nature of new credit being requested
5. the types of credit that the borrower has already used
One of the most rapidly growing areas of lending over the past decade
real estate loans
the difference between a home's estimated market value and the amount of the mortgage loans against it
equity
What are the two main types of home equity loans?
Traditional home equity loans
Lines of credit against a home's borrowing base
What was the purpose of the Bankruptcy Abuse Prevention and Consumer Protection Act?
#NAME?
an average of a debtor's past six months of gross income
means test
What is the trend of mergers and acquisitions driven by?
intense competition, deregulation, the search for the optimal size financial-services organization
What are three reasons on why mergers happen?
1. the stockholders involved expect to increase their wealth or reduce their risk exposure
2. Management expects to gain higher salaries and employee benefits, greater job security, or greater prestige from managing a larger firm
3. both stockholders and
Why would a merger constitute lower risk?
#NAME?
How would a merger provide a tax benefit?
If the acquired firm has earnings losses that can be used to offset taxable profits of the acquirer
How do mergers reduce competition?
when two competitors are allowed to merge, the public is served by fewer rivals for their business
the number of shares of stock offered by an acquiring bank for each share of stock of the acquired bank
exchange ratio
spreading the firm's ownership over more stockholders so that the average shareholder's proportion of firm ownership declines
- results from offering the acquired firm's stockholders an excessive number of new shares relative to the value of their old sha
Dilution of Ownership
What are the two methods that mergers usually use?
1. Pooling of interests
2. Purchase accounting
merger partners merely sum the volume of their assets, liabilities, and equity in the amounts recorded just before their merger takes place
pooling of interest
the firm to be acquired is valued at its purchase price and that price is added to the total assets of the acquirer
- the acquirer records the acquisition at the price paid but must value the acquired firm at market value plus goodwill (if the acquisition
purchase accounting
Is goodwill figured when using the pooling of interests approach?
no
Which merger method was eliminated in 2001?
pooling of interest method
________ often put together a broad range of assets, including stocks, real estate, commodities, and mortgage-backed securities, in an effort to profit no matter which direction the market goes
Hedges
The activities of a trust department center upon establishing a ________ relationship who are in charge of protecting a customer's property, making asset management decisions, planning a customer's estate, ensuring that estate property is passed in timely
fiduciary
representing the excess amount above each share of stock's par value paid in by the institution's shareholders
surplus
The largest source of capital for commercial banks is _________
surplus
measured by the par (face) value of common equity shares outstanding, which pay a variable return depending on whether the issuing institution's board of directors votes to pay a dividend
common stock
measured by the par value of any shares outstanding that promise to pay a fixed rate of return (dividend rate); may be perpetual, nonvoting, have only limited life, or be issued as trust preferred stock (which has features of both debt and equity securiti
preferred stock
representing the net earnings that have been retained in the business rather than being paid out as dividends
undivided profits
representing funds set aside for contingencies, such as legal action against the institution, as well as providing a reserve for dividends expected to be paid but not yet declared and a sinking fund to retire stock or debt in the future
equity reserves
representing long-term debt capital contributed by outside investors, whose claims legally follow the claims of depositors; these debt instruments may carry a convertibility feature, permitting their future exchange for shares of stock
subordinated debentures
where the financial firm holds ownership shares in other businesses
minority interest in consolidated subsidiaries
debt securities repayable from the sale of stock
equity commitment notes