NONBANK FINANCE By Minxin Xiqiu Yanjie Amanda. M UTUAL F UND are financial intermediaries that pool the resources of many small investors by selling.

NONBANK

FINANCE

By Minxin

Xiqiu

Yanjie

Amanda

MUTUAL FUND

are financial intermediaries that pool the resources of many small investors by selling them shares and using the proceeds to buy securities.

ADVANTAGES OF MUTUAL FUNDS

Diversification Risk reduction by diversifying the portfolio of securities.

Economies of Scale Volume discounts on brokerage commissions and lower transaction costs in purchasing securities.

LiquidityAllowable to convert into cash at any time.

Simplicity Buying a mutual fund is easy!

DISADVANTAGE OF MUTUAL FUNDS

No Guarantees.Active trading contributes to high costs which lower fund returns. Tax consequences can be a disadvantage

• tax impacts of asset trading are passed through to investors.• tax bill can be large even when the Net Asset Value falls.

Dilution- result of a successful fund getting too big.

MUTUAL FUNDS GROWTH

Large increase in their market share since 1980. Specialize in debt instruments which first appeared in 1970s. before 1970, mutual funds invested almost solely in common stocks. 80% of mutual funds are held primarily by households. In 1960, only 6% of household held mutual funds shares. In recent years, 6% has been increased to around 50%.

CONCERNS ABOUT SOVEREIGN WEALTH FUNDS

Sovereign Wealth Funds: • 1st concern: the size of these funds increases. •2nd concern: Using these investments for political purposes.• 3rd concern: Lack of transparency. This is why organizations like the International Monetary Fund (IMF) and the Organization for Economic Co-operation and Development (OECD) proposed rules to increase the amount of informations.

MUTUAL FUNDS SCANDALS

In September 2003, New York Attorney General Eliot Spitzer accused a number of mutual funds of exploiting conflicts of interest in which they allowed favored customers to engage an illegal, late trades in the fund.SEC have addressed the scandals by insisting

that directors of mutual funds be more independent from the funds’ managers, requiring that trades after 4p.m, be priced at the next day’s net asset value, increasing enforcement of fees for redeeming mutual fund shares, and increasing transparency of fund operating practices to the public.

STRUCTURE OF MUTUAL FUNDS

Open-end Fund: can be redeemed at any time at a price that is tied to the asset value of the fund. Closed-end Fund: is a publicly traded investment company that raises a fixed amount of capital through an initial public offering (IPO). The fund is then structured, listed and traded like a stock on a stock exchange.

MONEY MARKET MUTUAL FUNDS

o An open-end mutual funds which invests only in money markets.

These funds invest in short term (one day to one year) debt obligations such as Treasury bills, certificates of deposit, and commercial paper.

Writing checks on the fund’s account is allowed.

The biggest risk is that inflation will outpace the funds’ returns.

HEDGE FUNDS An aggressively managed portfolio of investments that uses advanced investment strategies such as leveraged, long, short and derivative positions in both domestic and international markets with the goal of generating high returns.

The primary aim of most hedge funds is to reduce volatility and risk while attempting to preserve capital and deliver positive returns under all market conditions.

Investment in hedge funds is illiquid.

They are similar to mutual funds in that investments are pooled and professionally managed, but differ in that the fund has far more flexibility in its investment strategies.   

GOVERNMENT INVOLVEMENT IN FINANCIAL INTERMEDIATION In two basic ways 1) Setting up Federal credit agencies that directly engage in

financial intermediation 2) Supplying government guarantees for private loans

FEDERAL CREDIT AGENCIES

Was created in order to Promote Residential housing, the government has created a number of government agencies that provide funds directly or indirectly to the mortgage market.

THREE AGENCIES

GNMA-Government National Mortgage Association(Government Sponsored Enterprises)

FNMA-Federal National Mortgage Association FHLMC-Federal Home Loan Mortgage

Corporation.

GOVERNMENT INVOLVEMENT IN AGRICULTURE

The Farm Credit System(Farm Credit Banks, various farm credit associations)

Federal Agricultural Mortgage Corporation issue securities and then use the proceeds to make loans to farmers.

MORAL HAZARD PROBLEM

Government backing of GSE debt led to banking crises in the 1980s and the early 1990s.

Reason was government in effect guarantees GSE debt, market discipline to limit excessive risk taking by GSEs is quite weak.

THE FUTURE OF FINANCIAL INTERMEDIATION AND REGULATION

1) A financial Products supermarket 2) What I will call an all-in bank

VENTURE CAPITAL FUNDS A venture capital fund make investment in new

start-up business, often in technology industry. Most venture capital funds have a fixed life of 10 years, with the possibility of a few years of extensions to allow for private companies still seeking liquidity. Venture capital firms are very important in driving the economic growth in recent years because they have funded so many successful hi-tech firms like APPLE and Microsoft.

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PRIVATE EQUITYPrivate equity is money invested in companies that are not publicly traded on a stock exchange nor invested as part of buyouts of publicly traded companies in order to make them private companies.

Private equity fund is a pooled investment vehicle used for making investments in various equity (and to a lesser extent debt) securities according to one of the investment strategies associated with private equity.

Private equity funds includes:

venture capital funds Capital buyout funds

CAPITAL BUYOUT FUNDS Instead make investments in established

businesses, in many case, buy publicly traded firm through Leverage buyout. Leverage buyout occurs when a financial sponsor acquires a controlling interest in a company's equity and where a significant percentage of the purchase price is financed through leverage (borrowing). The assets of the acquired company are used as collateral for the borrowed capital, sometimes with assets of the acquiring company. The bonds or other paper issued for leveraged buyouts are commonly considered not to be investment grade because of the significant risks involved.

SUMMARY Both venture capital and capital buyout funds

have been highly profitable. Venture capital funds make investments in start ups, and capital buyout funds make investments in established companies, often taking publicly traded firms private.

FINANCE COMPANIES Acquire funds by issuing commercial paper or stocks and

bonds or borrowing from banks. They use the proceeds to make loans that are particularly

well suited to consumer and business needs. They borrow in large amounts and lend in small amounts.

Different from banking institutions which collect deposits in small amounts and then often make large loans.

They lend to many of the same customers that borrow from banks but they are unregulated compared to commercial banks and thrift institutions.

There are regulations on the amount they can loan to individual consumers and the terms of debt contract .

No restrictions on how they pursue branching, the assets they hold, or how they raise their funds.

This is why they can tailor their loans to customer needs better than banking institutions.

3 TYPES OF FINANCE COMPANIES Sales Finance Companies: are owned by a particular retailing

or manufacturing company and make loans to consumers to purchase items from that company. Sale finance companies compete directly with banks for consumer

loans. Ex: Sears Roebuck Acceptance Corporation finances purchased of

goods and services at Sears stores. Consumer Finance Companies: make loans to consumers to

buy particular items. They are separate corporations or are owned by banks Typically these companies make loans to consumers who cannot

obtain credit from other sources and charge higher interest rates. Business Finance Companies: provide specialized forms of

credit to businesses by making loans and purchasing accounts receivable(bills owned to firm) at a discount. This provision of credit is called factoring. Besides factoring, business finance companies also specialize in

leasing equipment , which they purchase and then lease to businesses for a set of number of years.

SECURITIES MARKET OPERATIONS

The smooth functioning of securities market, in which bonds and stocks are traded, involves several financial institutions Securities Brokers and Dealers Investment banks Organized Exchanges

None of these institutions were included in our list of financial intermediaries because they do not perform intermediation function of acquiring funds by issuing liabilities and then using the funds to acquire financial assets.

Can be though of as “financial facilitators”.

INVESTMENT BANKING When corporations wishes to borrow(raise) funds, it normally hires an investment

banker to help sell it securities.

First they advise the corporation on whether it should issue bonds or stock. If they suggest the corporation to issue bonds investment bankers give advice on what

the maturity and interest payments on the bond should be. If they suggest the corporation to sell stock they give advice on what the price should be.

Easy to do if the firm prior issues currently selling in the market called seasoned issues

When the firm issues stock for the first time in an initial public offering it is more difficult to determine what the current price should be.

After the corporation decides which financial instrument to issue it offers issue to underwriters- investment bankers that guarantee the corporation a price on the securities and then sell them to the public.

If the issue is small one investment bank will underwrite it If the issue is large, several investment banking will underwrite it, thus limiting the risk

one investment bank will take.

The underwriters sell the securities to the general public by contracting potential buyers, such as banks and insurance companies, directly.

SECURITIES BROKERS & DEALERS Securities brokers and dealers conduct trading in

secondary markets. Brokers: act as agents for investors in the purchase or sale

of securities. Their function is to match buyers with sellers, a function for which they are paid brokerage commissions.

Dealers: link buyers and sellers by standing ready to buy and sell securities at given prices. Therefore they hold inventories of securities and make their living by selling these securities for a slightly higher price than they paid for them. High risk because they hold stocks whose prices can rise or fall.

Brokerage firms: engage in all three securities market activities, acting as brokers, dealers, and investment bankers. Brokerage firms started to engage in activities that traditionally

conducted by commercial banks.

ORGANIZED EXCHANGES

Organized stock exchanges actually function as a hybrid of an auction market and a dealer market.

Securities are traded on the floor of the exchange with the help of a special kind of dealer-broker called a specialist.

Specialist matches buy and sell orders submitted at the same price and so performs a brokerage function. However if buy and sell order do not match up the specialist buys stocks from a personal inventory of securities, performing a dealer function.

SECURITIES EXCHANGE COMMISSION REGULATIONS Investment banks

The activities of investment banks and the operation of primary markets are heavily regulated by the Securities and Exchange Commission.

Issuers of new securities to the general public (for amounts greater than 1.5 million in a year with a maturity longer than 270 days) must file a registration statement with the SEC and must provide potential investors with relevant information on securities.

They than need to wait 20 days after the registration statement is filed with the SEC before it can sell any of the securities. After 20 day waiting period the securities can be sold.

Securities Brokers and Dealers The Securities Exchange Commission restricts brokers and dealers

from misrepresenting securities and from trading on insider information, nonpublic information known only to the management of a corporation

Organized Exchanges Have the authority to impose regulations that govern the behavior of

brokers and dealers involved with exchanges, but it also has the authority to alter the rules set by the exchange.

Question?