Financial Institutions.chapter Threet

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Financial Institutions

Chapter Three



Central Banks Functions

Functions of the Central Bank:

1.The implementation of monetary andexchange rate policy.

2. The management of the national debt.

3. The supervision of the banking sector.

4. Acting as the banker to the Centralgovernment and the commercial banks.

5. Acting as lender of last resort.



1. Implementation of monetarypolicy

• The Central Bank activates the economythrough its policies. It influence themonetary base by:

• Purchases of treasury bills and otherinstruments ( bank of Israel purchasingdollars).

• This increases the money supplies,raising T Bills prices and thus lowerings.t.rate.



• Conversely:

• Sale of treasury bills to private sectordecreases money supply.

• Lower price of the T. Bill

• Increases interest rate



2. Management of National Debt

• Government Deficit ( revenue-expenses)is financed by domestic or overseasresidents

• The summation of all the past borrowingby local and central government is calledNational Debt.

• Holder repaid by issuing new debt.



3. Supervisory Function

• 1. licensing deposit taking Institutions

• 2. Monitoring the Banks and lendinginstitutions.

• Issues of Concerns:

• a. Capital Adequacy

• b. Liquidity• c. Risk Profile



Capital Adequacy

• A measure of the amount a bank holds toabsorb potential losses.

• Banks hold all kind of capital like equity incompanies, T Bills, bonds, buildings,Capital Reserve and working Capital

• The amount of reserve should relate to therisk they are taking.



Liquidity

• Since liquid assets earn v. low interest, banksgenerally like to keep very low liquidity.

• The amount of liquidity is determined by the

maturity structure of bank liability.• The shorter the maturity the greater the liquidity.

• The bank also needs to consider the volatility of

assets (loans) Liability (deposits).• The more volatile the greater the liquidity.



Risk Profile

• Risk management by the bank a) avoidingthe exposure to a particular firm or few b)exposure to one sector or industry.

• Off Balance Sheet exposure: the build upof risk whish is not reflected in the banksbalance sheet that shows primary its deposits ( liabilities) and loans (assets).Like exchange rate, interest rate derivatives etc…



Bank Risk Management

• VaR =Value at Risk JP Morgan 1990’s

• It measures the risk of a given dollar loss on a specifiedperiod of time.

• It became popular when the SEC asking banks to

increase the amount of capital they hold, Basel Accord inorder to help investors from risks taken by the bank.

• VaR considers, each asset class it holds, its volatility,correlation between bank assets and leverage, foreignexchange, bonds, loans equities…

• Daily VaR of $100m at 95% confidence y level.

• Weekly VaR $300m at 95%.

• It does not tell you



Black Swan and Nassim Taleb

• 5% that you lose 5oo billion ??????????? Does theformula indicates how much gain or lose in the other95% or the 19 days out of 20????

• Following 2007 VaR approach was in Question ???itslike the airbag that works all the time except on accident.

• NassimTaleb VaR is a Fraud

• The essence of Taleb book is that major extreme eventsare impossible to predict. So math does not work.



Nassim Taleb, the Black Swan



Insurance Companies

• Life insurance, (LT insurance) deathillness, retirement.

• General insurance, theft, property housescar accidents.

• Property insurance divided to personaland commercial.

• Commercial policies deal with malpractice,negligence, product liability…



Bancassurance phenomena

• 1980-1990 the liberalization or thederegulation of the financial markets

• Banks diversified into insurance business,they sold insurance policies.

• Banks setup subsidiaries or formedpartnerships with insurance companies



Mutual Funds (US) or Unit Trust (UK)

Alternatives for Saving Accounts.• They raise funds from the public investing them in a variety of

financial assets mostly equities domestic or international.• Low cost method for Portfolio diversification, professionally run, at

low cost management fees.

• The objective of the fund varies from high profit high risk to loweryields and stable investments. To income generating fund.• Some funds specializes in emerging markets, Asia Latin America, E.

Europe, or sectors funds, investing in Alternative Energy, Biotech,internet, or index linked fund S&P500, FTSE etc..

• Since Mutual Funds need to be valued daily, they restrict their

investment to listed securities that has a daily quotes.Most Mutual Funds are Open Ended.



Investment Company orInvestment Trust

• Companies that hold stake or shares in other companieswhich can engage in takeovers or breakups.

• Close Ended savers can purchase stock from otherholder. Unless the company issues other stocks.

• The value of the stock is determined by the value of itsnet assets/ No. of shares but also on a. quality ofmanagement, b. possible activities and

• As in MF the company the company has an objective forits investments.

• Diversity and professionalism.

• Gain tax issue with authorities.



Exchange Trade Funds ETF 1993

• Investment Vehicles made up of shares ,bonds, commodities or currencies thattrade on exchange at continuous basis.

• The average cost of ETF is low not like theMF.

• ETF symbol SPY Spider, S&P 500.

• ETF symbol DIA or Diamond, DJI.

• ETF QQQQ Tracking the Nasdaq



Exchange Trade Trusts ETF

• Like the MF they can specialize in particularIndex, sector, currency, commodities, marketsetc…..

• UNLIKE MF ( 2006) you can short on ETF, if thestock of the ETF falls the investors who wentshort on the ETF profits by buying back at alower price.

• OR buying an option on ETF allowing investorsto buy the ETF index at a certain price at acertain date in the future.



Prosperity and longevity enlarged PENSION FUNDS

• Tax concession

• Government, local governments,Institutions, companies…

• The Pension funds should be wisely andlow risked managed to ensure the returnsfor the pensioners.

• NOTE that the scheme has a constantinflow of funds and out flow.

• Decline in population/ life expectancy.



HEDGE FUNDS and GeorgeSOROS

• Hedge Funds are funds that seeks to make profitregardless were the market is going.

• If the mangers think that the market will rise hebuys stock index or futures or call options if they

think the market will fall they will sell the futuresbuy put options. SPECULATION

• It uses derivatives, futures, options leverage itsfunds for speculations.

• NO SEC supervision.• The manger of the fund makes 1-2% and 15-

25% of the profit.



GEORGE SOROS

• Quantum Fund



Quantum Fund- speculations

• Sept. 1992, Soros thought that the British poundwill go down against the deutschmark. Forcedout of exchange rate mechanism. thus they soldhuge amount of B Pound and boughtdeutschmark when the fund was devaluated

Quantum made 1 billion BP.• 14, February 1994, lost $600 m when they bided

against the yen thinking that the Yen willdepreciate it instead appreciated “St. Valentine

Day Massacre”. Clinton ( wanted a stronger yen)and Japan Prime Minister meeting. %5difference.



LTCM Long Term CapitalManagement- Nobel Prize

Winners Myron Scholes andRobert Merton ???????

• 1997 won Nobel Prize in Economics• 1998 LTCM Hedge Fund “Sholes and Merton as

fund managers”, Lost after making a massive betthat the spread between Corporate bonds and Tbills interest rate would narrow thus purchasing

$2,120b of corporate bonds, the results wereRussia’s default and the market looked for a highquality bonds dumping corporate bonds.

• The fund was saved by Merrill Lynch, GoldmanSachs JPMorgan.



Careful betting in Hedge Funds

• John Paulson setting a fund in 1994 calledPaulson and Co. with $2m of capital in the fund.By 2007 it went to $12.5 of assets ( 95%institutional capital) in the crash time he wentagainst the market making $2.5b of profit in2008.

• The fund was up 37%, while the average hedgefund lost 19%

• Paulson and Co Fund are example of carefulinvestment in Hedge Funds.



Private Equity

• Private Equity Firms: are privately owned limited liabilitypartnerships that raise funds to invest in a variety ofprivate companies or publicly traded ones.

• Example of raising Private Equity fund is investments in

banks, insurance sovereign wealth fund, endowments.• Investors need to realize that: a) its Medium to long term

investment (5-12 years) so its illiquid, b) a min. amountof capital is needed say $1m. c) investors should notexpect profit unless sales or profit is distributed by

Management. d) it’s a passive investment since youhave no control over decisions. E) high risk investmentthis means higher expectation for profitability.



Private Equity

• Its very important to realize that: Private Equityfunds used Leverage Buy Out LBO

• Leverage buy out is the take over of company oran asset by financing it from debt issues (

bonds) or bank loans the financing can reachbetween 50%- 99%. ( also note that interest ondebt is tax deductable expense).

• After the asset is bough and some

reorganization is done they look for the Exitstrategy a) sell it back to another company or b)go IPO c) divide it and sell it in segments.

• IPO Initial Public offering



Private Equity Funds

• Private Equity flourished between 2001-2007 estimated of $2.7 trillion in deals.

• After the crunch most of the business isgoing to Asia were money is easier to get.



Venture Capital Companies VC

• Venture Capital is a private capital used to finance thegrowth of small companies that are generally risky andlack long term trading records, for these companies, itsdifficult to secure financing from banks or capital

markets. So they seek VC to support them.• Private investors, pension funds, insurance companiesseek to invest in VCs

• VC lacks seed capital and managerial expertise

• The VC supports and accompany the company till itmatures and starts making profits then making an exiteither by IPO or sold to another company.



DO you know this guy 2004-2011



$100 billion company from theUniversity Campus: Facebook



COO – Chief Operating officerSherly Sandberg



Choose the Best in HumanResource



Apple 1982





Steve Jobs1954-2011



Steve Jobs and Steve Wizniak





Steve Jobs Speech in Stanford

• http:// www.youhttp://www.youtube.com/watch?v=D1R-jKKp3NA tube.com/watch?v=D1R-jKKp3NA

http://www.youtube.com/watch?v=D1R-jKKp3NA

http://www.youhttp//www.youtube.com/watch?v=D1R-jKKp3NA
















What do you conclude

• IT needs ONE to MAKE IT ALL ;;;;

• No need for money you get the seedsmoney

• TRUST YOUR SELF AND GO FORYOUR PASSION

LOOK FOR THE RIGHT PARTNER

YES YOU CAN



WAKE UP CALLS

• THE CURRENT MODERN ECONOMIESARE THE ECONOMIES OF INNOVATION

• A NEED FOR VCs

• ISRAEL AS A START UP NATION.• SINGAPORE

• IRELAND

• FINLAND NOKIA



Factoring Company

• Is an invoice discounting service when the

business suffers from cash shortage itdiscounts future inflows

• Bank subsidiary a finance house,

insurance company etc… all can beFactoring company

S i W lth F d



Sovereign Wealth Funds asglobal investors

• As for private investors in Private Equity or VCsfund also government with money surplus seeksinvestments.

• First fund Kuwait Investment Authority 1953.

• Abu Dhabi Investment Authority $875b fund• SAMA Saudi Arabia $431b.• Sovereign funds run $3.7 t. more than the hedge

funds and private equity companies.

• Funds have different strategies, from maximizeyield to regional development• Their power is increasing, Dubi fund acqiring the

ports•



Sovereign Wealth Funds



Oil Governments

L S i W l h F d



Largest Sovereign Wealth Funds2011



• End of Chapter three

Financial Institutions.chapter Threet

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