Lecture by Professor Dr. Md.

Jahangir Alam
Lecture 09 / Mar 05, 2009
Treasury bill (T-bill): Most popular money market financial instrument in the world is Treasury bill, of
which maturity period is one year or less. T-bill was first issued by the US government in 1929. Now it is
issued by all governments throughout the world to raise short term funds and to meet the expenses. It is a
direct obligation of the government. Tax revenues and any other sources of fund are used to repay the
holders of the t-bills.
Importance of T-Bill in the Financial System:
1. There is no default risk of t-bill.
2. T-bill has the ready marketability; it has a secondary market where holders can sell t-bills before
maturity.
3. T-bill has high liquidity; holders can convert t-bills into cash before maturity.
Types of T-bills:
1. Regular series bill: It is issued routinely every week or month in the competitive tender. Original
maturity of regular series bill is three months, six months, or one year.
2. Irregular series bill: It is issued when the treasury has special cash need. It is a package offering of t-
bill that requires an investor to bid for entire series bill, of different maturity periods. Successful
bidder must accept the bid at bid price.
Sales of T-bill:
T-bills are sold using the auction technique. So market decides the price and all bids for t-bill must be
expressed as a discount rate. A new regular t-bill is usually announced by the treasury on a particular day
of each week. It requires the investors to bid on the following day of announcement.
Participating in auction can be done in two ways –
1. Investor may appear in person to fill out the tender form to make an offer to the treasury.
2. Investor may place an offer through security dealer for a specific bill at a specific price.
There are two types of tenders –
1. Competitive tender: This is submitted by the large investors including banks, security dealers, and
any other depository institutions (insurance company, leasing company).
2. Non-competitive tender: This is submitted by the small investors and they do agree accept whatever
the bid price is determined at the auction. In this case investor must pay the full par value of the issue
for which he or she bids at the time the tender is made. Treasury gives the investor a refund check if
the price of the issue is less than the amount paid. The refund check represents the difference between
the amount paid and the actual auction price. The highest bid becomes the common price of the t-
bills.
Calculation of Yield on T-bill:
Bank discount method (360 days a year):
DR = ((Par Value – Purchase Price) / Par Value)*(360 / Days to Maturity)
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Investment Rate Method (365 days a year):
IR = ((Par Value – Purchase Price) / Purchase Price)*(365 / Days to Maturity)
** An individual purchases a t-bill for $97 on a $100 par value, and the maturity is 180 days. Calculate
both DR and IR.
Answer:
DR = (($100 - $97) / $100) * (360 / 180) = 6%
IR = (($100 - $97) / $97) * (365 / 180) = 6.27%
Yield before Maturity: If the investor sells the t-bill before maturity then yield before maturity is to be
calculated.
Yield before Maturity = Original DR + Change in Discount Rate over the Holding Period
Change in Discount Rate over the Holding Period =
((Original Maturity Period – Holding Period) / Holding Period) * Change in Discount Rate
** An investor buys a t-bill with 180 days maturity at a price that result in DR of 6%; after 30 days the
investor needs immediate cash and is forced to sell at a price that result in DR of 5.8%. What is investor’s
holding period yield?
Answer:
YBM = 6% + ((180-30)/30) * (6% - 5.8%) = 7%
Role of T-bill in the Money Market:
1. Government raises short term fund by issuing t-bills.
2. Government implements monetary policy through t-bill. Government increases the money supply by
returning back the t-bills and it stimulates the economic activities. Government decreases money
supply by selling the t-bills, and decreases the overall demands of goods and services.

Lecture 10 / Mar 09, 2009

Certificate of Deposit: CD is issued by the depository institutions, and they are interest bearing deposits
for a set period of time.
¾ There are many types of CD issued by the depository institutions. True money market CDs are
negotiable CD, which may be sold in the money market before maturity, means there is a secondary
market. Negotiable CDs may be of two types –
1. Registered with the issuing company
2. Issued in a bearer form to the investors
¾ Negotiable CDs in bearer form are more convenient for resell in the secondary market because they
are in the hands of the investors who own those.
¾ Interest rates on large CDs are set by negotiating between issuing institutions and investors.
¾ When loanable funds are scarce, the issuing institutions offer high interest rate; and when loanable
funds are more abundant, the interest rates fall.
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¾ Interest from CD = (Term in Days / 360) * Principal * Yield to Maturity (YTM)
YTM → Promised interest rate by the issuing institutions at maturity
Advantage of CD:
1. Readily marketable at low risk
2. May be purchased at any desired maturity
3. Carries somewhat higher yield than that on t-bills.
Types of CDs:
1. Variable Rate CD: It carries maturities up to five years and interest rate is adjusted every three
months, or six months.
2. Roll over CD: It is composed of three months, or six months CDs and extended for further period.
3. Installment CD: It allows customer to make a small initial deposit in the account and then gradually
build up the balance to some target level.
4. Special CD: It provides the investors with penalty free withdrawals on some selected anniversary
dates.
** If a business firm purchases negotiable CD of tk. 100,000 for 6 months at 7.5% interest rate, then what
will be the interest amount?
Answer:
Interest Amount = (Term in Days/360) * Principal Amount * Yield to Maturity
= (180/360) * 100,000 * 7.5% = tk. 3,750

** A 6 months tk. 100,000 worth CD, bearing 7.5% interest rate at maturity. If the investor sells the CD 3
months prior to the maturity for tk. 115,000, then what would be the investment rate?
Answer:
IR = ((Selling Price – Par Value) / Par Value)* (365 / Days to maturity)
= ((115,000 – 100,000) / 100,000) * (365/ (180-90)) = 60.83%

Lecture 11 / Mar 12, 2009

Commercial Papers: These are short term, unsecured promissory notes, usually issued by well-known
and financially strong corporations.
Types of Commercial Papers:
1. Direct Paper: It is issued directly to the investors by the issuing company. Usually this issuing
corporation is financially strong.
2. Dealer Paper: Issuing companies may sell commercial papers directly to the dealers, and the dealers
attempt to resell the papers at the highest possible price in the market. Here the dealers carry the risk.
The companies may also sell the papers to the investors with the help of the dealers. Dealers sell the
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papers at the best available price and receive commissions from the issuing companies. It carries risk
for the issuing companies, because all the issues may not be sold. Dealer papers are generally issued
by small firms with low credit ratings. So it carries greater risk for the investors; interest rate on the
dealer paper is higher than that on the direct paper.
Characteristics of Commercial Papers:
1. Lower Cost – interest rate on commercial paper is less than bank loan rates. It is the cheaper source of
funds than issuing long term bonds, or selling preferred stocks.
2. Quality of Paper – Most commercial papers are of high quality, because they are issued by large,
deputed, and financially strong companies; and commercial papers are treated as the close substitute
of treasury bills.
3. Guarantee of Paper – Banks or lending institutions issue documentary notes for the borrowing
companies and they promise repayment of principal or interest, if the borrowing company fails to
make repayment.
Maturity Periods of Commercial Papers:
Maturity periods of commercial papers rage from three days to nine months.
Calculation of Yield on Commercial Papers:
Bank discount method (360 days a year):
DR = ((Par Value – Purchase Price) / Par Value)*(360 / Days to Maturity)
Investment Rate Method (365 days a year):
IR = ((Par Value – Purchase Price) / Purchase Price)*(365 / Days to Maturity)
Advantages of Commercial Papers:
1. Corporation can raise funds at low interest rate than the interest rate on bank loans.
2. Large amounts can be borrowed conveniently by issuing commercial paper, because regulations limit
the amount of money a bank can lend to single borrower, but corporations frequently require credits
in excess of that limit. So selling the commercial paper is generally much faster than trying to
hammer out for loan from several banks.
3. The ability to issue commercial paper gives a company considerable leverage while negotiating with
banks and other lenders for loans. So a banker who knows that a corporation can issue commercial
paper is more likely to offer advantageous terms on loans and may be more receptive for meeting
credit needs of the corporations.
Disadvantages of Commercial Paper:
1. Opportunities for resell of the commercial paper in the secondary market are limited.
2. It may be difficult to raise required fund at a time at a reasonable interest rate.
3. Commercial paper does not permit early retirements.
Buyers of Commercial Papers:
1. Non-financial corporations
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2. Small banks
3. Pension fund
4. Insurance companies
Buyers regard commercial paper as the low risk outlet for their surplus funds.

Lecture 12 / Mar 16, 2009

Banker’s Acceptance: It provides financing to facilitate import and export of goods. Usually it arises
because most exporters are uncertain of the credit standards of the importers to whom they shift goods.
Exporters usually rely on the acceptance financed by the bank. Banker’s acceptance is a time-draft drawn
on the importer’s bank.
Steps of L/C:
1. To pay for the shipment of goods the importer applies to a bank for secured credit. Once the credit is
approved by the bank, it issues a letter of credit in favor of the exporter.
2. The letter of credit authorizes the exporter to draw a time-draft for a specified amount against the
issuing bank provided that the exporter will send the proper shipping documents giving the issuing
bank temporary title to the imported goods.
3. By issuing letter of credit, an issuing bank unconditionally guarantees to pay the face value of the
acceptance at maturity, and shields the exporter in the international market from default risk.
4. Exporter submits the time-draft to his bank, and the exporter’s bank forwards the time draft, and the
shipping documents (if the goods are shipped) to the issuing bank.
5. If the issuing bank finds the document correct, it stamps ACCEPTED on the face of the draft, and
two things happen –
a. Banker’s acceptance is created.
b. The issuing bank acknowledges an absolute liability that must be paid in full.
6. The banker’s acceptance is held by the bank as an asset, or sold to the dealer. When it matures the
acceptance is presented by its holders for payment.
Maturity: The maturity of banker’s acceptance ranges from 30 days to 270 days, most commonly it is 90
days.
Yield on Banker’s Acceptance:
Acceptances are sold in the open market at a discount rate like t-bills, and it is considered as a prime
quality money market instrument; because this is issued by well-regarded banks. The yield on acceptance
is slightly higher than that on t-bills; because t-bill is 100% risk-free. Again yield on acceptance is closed
to that on certificate of deposits. So, to many investors banker’s acceptance is a close substitute of t-bills,
CDs, and commercial papers.
Bank discount method (360 days a year):
DR = ((Par Value – Purchase Price) / Par Value)*(360 / Days to Maturity)
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Investment Rate Method (365 days a year):
IR = ((Par Value – Purchase Price) / Purchase Price)*(365 / Days to Maturity)
Disadvantage of Banker’s Acceptance:
¾ Limited secondary market
Buyers of Banker’s Acceptance:
1. Banks
2. Corporations
3. Government agencies
4. Security dealers
5. Insurance companies

Lecture 13 / Mar 30, 2009

Federal Fund: Federal fund is the reserve balances of banks and other depository institutions at central
bank. Banks and other depository institutions must deposit funds in special reserve account with the
central bank.
Why banks and other depository institutions keep reserve in the central bank?: Banks and other
depository institutions keep reserves in the central bank to meet their reserve requirement and to get
support when money is desired by the account holders. Federal fund is called the heart of the money
market, because it provides huge amount of fund in the money market for bank to bank credit.
Legal Reserve Requirement: It is the fraction of the deposit made by the public in a bank or a
depository institution.
Total reserve of a bank has two parts:
1. Legal reserve requirement
2. Excess reserve – kept in the bank’s own volt
Calculation of legal reserve requirement:
¾ First the daily average deposit held by a bank or deposit institution over a two week period is
calculated.
¾ This daily average deposit is then multiplied by required reserve percentage, which is decided by the
central bank to determine the amount the amount of legal reserve requirement that must be held by
each institution at the central bank.
¾ Federal bank provides very short term loan and these funds can be transferred within different
depository institutions, within thr same day.
¾ For making transaction, the borrowing bank is given a check drawn in the lending bank’s reserve
account and the check is immediately payable before close of business on the same day. The lending
bank is also given a check drawn on the borrowing bank’s reserve account, and the next day the funds

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are automatically returned to the lending bank’s reserve account. Both checks mast pass through the
clearing house of central bank.
Federal Fund Participants:
1. Commercial banks
2. Non-bank financial institutions
¾ Leasing companies
¾ Insurance companies
¾ Mortgage banks
¾ Branches of foreign banks
¾ Credit union
¾ Pension fund
¾ Saving and loan association
Eurocurrency Deposits: It represents the largest of all money market instruments worldwide. Because of
the tremendous worldwide need for funds in USD, Pound Sterling, and other stable currencies,
Eurocurrency arises in the money market.

Uses of Eurocurrencies: Companies operating in other countries require a huge volume of other national
currencies to carry out transaction in these countries. These deposits are loaned to private organizations
and government abroad that need USD and other dominating currencies.
1. These funds are used by the borrowers to finance import and export of goods
2. To supplement government tax revenues
3. To provide working capital needs for the foreign operations of multinational companies
4. To provide liquid reserves for banks
Maturity: One day to one year.
Risks:
1. Political risk
2. Default risk
3. Market risk – Because Eurocurrency deposits are volatile and highly sensitive to fluctuations on
interest rate and currency prices.
Sources:
1. Balance of payments
2. Foreign investment
3. Tourism
Advantages:
1. It makes possible an efficient mobilization of fund around the glob.
2. It encourages cooperation among nations
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3. It aids the financial operations of corporations and governments around the glob
Disadvantage:
The capacity to mobilize the massive amount of funds may contribute to instability in currency values in
different countries, and can cause chaos in any particular nation’s monetary and fiscal policies.

Lecture 14 / Apr 02, 2009

Categories of Financial Institutions:
1. Depository Institutions
2. Contractual Institutions
3. Investment Institutions
Depository Institutions: Depository institutions collect funds from deposit accounts offered to the
public. Depository institutions are
1. Commercial Banks
2. Savings and Loan Association
3. Saving Banks
4. Credit Unions
5. Money Market Funds
Contractual Institutions: Contractual institutions collect funds by offering legal contracts to protect the
savers against the risk. Contractual institutions are
1. Life Insurance Company
2. Property/Casualty Insurance Company
3. Pension Funds
Investment Institutions: Investment institutions collect funds by selling shares to the public. Investment
institutions are
1. Finance Companies
2. Investment Banks
3. Real Estate Investment Banks
4. Mortgage Banks
5. Leasing Companies
Commercial Banks: They are the dominant financial institution in the economies of most countries.
They offer to the public
1. Deposit Schemes
2. Credit Services
3. Payment Services (Business to Business payments)
4. Security Underwritings (They assist corporations and governments to sell securities)

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The name ‘commercial’ implies that these banks devote most of their resources to meet the financial
needs of the business firms.
Reserves of the Commercial Banks:
1. Primary Reserves – Primary reserves consist of cash in the bank’s own volt, and deposit with other
banks.
Purpose – Primary reserves serve as the first line of defense against the withdrawal of the depositors,
and to meet the credit needs of the customers.
2. Secondary Reserves – Secondary reserves consist of the securities acquired in the open markets.
Major amount of the secondary reserves consist of the government bonds and notes as they have tax
exemption, and small amount consist of the corporate bonds and notes.
Purpose – Secondary reserves are acquired to earn some income from the idle money.

Types of Deposits:
1. Demand Deposit – Usually non-interest bearing deposit, known as current account. It is used to make
payments from one business to another business.
2. Savings Deposit – Interest bearing deposit and offers lowest interest rate. Depositors can withdraw
money from the savings deposit anytime.
3. Time Deposit – Interest bearing deposit, carries a fixed maturity, and usually offers the highest
interest rate a bank can pay.
Loan: Bank lends money for different purposes and loan is the principal business of the commercial
bank. It is the highest yielding asset of a bank, and it provides the largest portion of a bank’s revenue.
Type of Loans:
1. Direct loan to business:
a. Both short term and long term
b. Provides short term loan to provide working capital needs
c. Provides long term loan to finance the purchase of machinery and equipments.
d. Provides long term loan to finance the construction of residential, and commercial buildings
(shopping complex, office buildings)
2. Direct loan to individuals:
a. Both short term and long term loan
b. Provides short term loan for the purchase of commodities
c. Provides long term loan to finance the purchases of home appliances, automobiles, and even
home, home furnishing
d. Provides long term loan for college and university education
3. Loans of reserve to other banks

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Sources of Funds:
1. Equity capital supplied by the bank shareholders; it provides a minor portion (about 9%) of the total
funds of the bank. The purpose of this equity capital is to keep a bank open it faces operating losses.
2. Deposit schemes
3. Non-deposit sources of funds
a. Loan from federal reserves of other banks
b. Security Repurchase Agreements
c. Issuance of Capital Stocks
4. Revenues
a. Interest on loans (mostly)
b. Service charge on deposit accounts
c. Interests/Dividends on securities held by the bank
Expenditures:
1. Interest on deposits and other borrowed funds (major expenditure)
2. Salaries and wages of the employees
3. Other operating expenses

Lecture 15 / Apr 06, 2009

International Banking: It is the bank’s expansion in the international market.
Types of International Banking:
1. Representative Office - Representative offices are eyes and ears of a bank in the foreign market. They
can not take deposits, or make loans. They provide required information about the bank service
facilities to the customers, and make a liaise with the customers in the foreign market.
2. Branch Office - Branch offices offer all, or most of the services that provided by the home bank.
3. Subsidiary - Subsidiary is the acquisition of the overseas bank with the existing clientele by retaining
its own charter and the capital stock.
Branch Banking: It consists of different branches in different locations, and services are provided by
multiple offices owned by the same corporation.
Advantages of Branch Banking:
1. Broader market access
2. Can collect deposits from various regions
3. Can reduce risk by offering loans to various sectors
Reasons for Bank Failure:
¾ Internal Factors –
1. Willingness to accept greater risk in operation
2. Rapid expansion of bank services without proper evaluation
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¾ External Factors –
1. Crimes (bank robbery)
2. Decline in economies
3. Fall in stock prices – issuing new stocks becomes difficult
4. Bad loans
Creation of Money by Banks: Banking system has the power to create money equal to a multiple of any
excess reserve deposited with a bank.
Steps in Money Creation Transaction:
1. When a deposit (tk. 1,000) appears at a bank (Bank A), it is required to meet the legal reserve
requirement (20%). So Bank A requires placing tk. 200 in its Federal Reserve account. Now it leaves
excess amount reserve of tk. 800. Since the excess reserve earn no interest income, the bank will try
to loan out this excess reserve.
2. It is observed that when a bank makes loan, the borrowed funds are withdrawn immediately. And it is
likely that most borrowed funds will be deposited in other bank. Ultimately the total value of deposit
grows rapidly, as funds flow from bank to bank within the financial system. So by making loans
whenever excess reserve appears, the banking system creates total deposits several times larger than
the original amount of the deposit.
Example of Money Creation Transaction:
Initial deposit = tk. 1,000
Legal reserve requirement (r) = 20%
Bank Deposit Legal Reserve Requirement Make Loan
A Tk. 1,000 (1,000*1) Tk. 200 Tk. 800
B Tk. 800 (1,000*(1-r)) Tk. 160 Tk. 640
C Tk. 640 (1,000*(1-r)2) Tk. 128 Tk. 512
D Tk. 512 (1,000*(1-r)3) Tk. 102.4 Tk. 409.6
.
.
.
Total Effect in the Banking System
= 1,000 (1+ (1-r) + (1-r)2 + (1-r)3 + ………+ (1-r)∞
=1,000*((1-(1-r) ∞+1)/ (1-(1-r))) =1,000/r =1,000/0.2 = Tk. 5,000
Deposit Multiplier = 1 / Legal Reserve Requirement
Total Effect = Initial Deposit * Deposit Multiplier
Money Destruction: This can be done if money is withdrawn from a bank, in the opposite direction of
the money creation.

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Lecture 16 / Apr 16, 2009
Savings and Loan Association: This is the largest of all NBFIs, started in 1831. It started accepting
deposits from middle income people, and lending these funds to the depositors. Savings and Loan
Association emphasizes long term loans, especially mortgage loans for the purchase of apartments,
duplexes, and single family homes.
Services and Investments of Savings and Loan Association: Due to competition from other financial
institutions, Savings and Loan Associations have been forced to diversify their operations for providing a
variety of services, and for making investments.
• Services –
1. Checking accounts
2. Credit cards
3. Consumer lending
4. Commercial real estate loans
5. Trust Services
• Investments –
1. Mutual funds
2. Corporate and Government Bonds
Mutual and Stockholder-owned S&Ls:
Many S&Ls are mutuals and, therefore, have no stockholders. However, a growing number of
associations are converting, or have converted to stock form. Stockholder-owned S&Ls can issue capital
stock to increase their net capital worth – a privilege that is particularly important when a S&L is growing
rapidly and needs additional source of long term capital. Stockholder-owned S&Ls are, on average, larger
in size than mutuals.
Sources of Funds:
1. Money Market Deposit Account
2. Certificate of Deposit
3. Securitized Assets
4. Debt Securities
5. Loan Sales
Savings Banks: It is for the small savers. It began in 19th century in Scotland to meet the needs of the
small savers. Like Savings and Loan Association, Savings Bank is also owned by the depositors, but
earnings are paid to them as dividends. Savings Banks play active role in the residential mortgage market,
but they are more diversified than Savings and Loan Associations in investment. They also purchase
corporate and government bonds like Savings and Loan Associations, but in addition they also can
purchase the common stocks. They make consumer loans, also invest in commercial mortgages. Savings
Banks provide mortgage loans to build apartments, duplexes, and single family homes. They also provide
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consumer loan for the purchase of home appliances, automobiles, to meet the educational and medical
expenditures.
Sources of Funds: Savings Banks provide a variety of savings instruments like savings deposit, and time
deposit.
There is little distinction among the services provided by the commercial banks, savings and loan
associations, and savings banks. So they are readily convertible from one form to another.
Credit Unions: Credit Union is the cooperative and self-help associations of individuals, and profit
making is not the main goal of the Credit Unions. Credit Unions are organized around a common
affiliation, or common bond among the members. These are mainly created for low income people,
especially for the industry workers, first time in Germany, because small cash loans for them were with
extremely high interest rate from other financial institutions. Members are technically owners of the
Credit Unions, they receive dividends, they share any losses, and they have the voting right – each
member has only one vote whatever the size of his or her account is.
Members:
1. Employees work for the same employer, or a group of related employers
2. Members of a social organization
3. Musollis of a mosque
4. Members of a labor union
5. Residents of a particular area
6. Associations of retired persons
Services and Investment of the Credit Unions:
1. Credit Unions offer members the share accounts, and members can deposit in the share account.
2. Credit Unions offer the members loans at low interest rate
3. Many Credit Unions offer payroll savings; an employee can set aside a portion of the salary in the
savings account
4. Many Credit Unions offer life insurance to the members free of cost, if law permits
5. Credit unions can accept a smaller spread due to low operating cost, and low interest rate on loans
provided to the members. Also frequently, the sponsoring employer, or association provides free
office facilities, and credit union members elect officers and directors who frequently serve with no
compensation at all.
6. Credit Unions are allowed to invest in certificate of deposits and banker’s acceptances, because they
are provided by the financial institutions, but are not allowed to invest in commercial papers as they
are riskier
Reasons for Lowest Default in Credit Unions:
1. Credit unions make fewer business loans which particularly in down turning economy can be very
risky credits.
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2. There is a common bond among the credit union members which seems to encourage most borrowing
members to repay their loans in a timely fashion.
Money Market Funds: It started in 1972; it pulls the savings of the individuals and businesses to the
share accounts. Money Market Fund can invest in short term, high quality money market instruments –
treasury bills, certificate of deposits, banker’s acceptance, commercial papers, and bonds issued by the
government. Money Market fund can maintain high liquidity, as the assets have short maturity. So it can
avail better investment opportunity when it appears.
Characteristics:
1. It declares dividends on daily basis, and transfers the earnings to the customer accounts.
2. It allows the customers to write checks to withdraw money from accounts.
Advantages:
1. It serves as cash management vehicles for the deposit holders
2. Earnings on funds can be used for daily transactions
3. It serves as tax sheltering vehicles when tax exempt investments are chosen
4. It provides a temporary depository of liquid funds, so it can avail better investment opportunity when
it appears
5. It serves as a safety heaven for savings, because funds are invested in the high quality securities.
Disadvantages:
1. Money Market Fund share accounts are not government insured
2. The difference between the rate of return on the money market accounts and that on the bank account
is becoming narrow.
Factors for Choosing Money Market Funds:
1. Increased public concerns about risk in the economy and the financial sector.
2. There is no legal interest rate ceilings limiting what a money fund can pay to its shareholders, and
unless a money fund imposes them, there are no penalties for early withdrawal of funds.

Lecture 17 / Apr 20, 2009

Mutual Funds: They collect fund by selling shares to the middle income public and who have little
knowledge about the operations of the financial market. Mutual fund invests money in both capital market
(high yielding corporate bonds and stocks) and money market (CDs, T-bills, and commercial papers).
Mutual fund divides funds into four categories:
1. Index Fund – Usually mutual funds buy stocks from the local companies traded in the local stock
exchanges. They select companies according to some established criteria in term of dividend and
price appreciation.
2. Global Fund – Funds are invested in stocks and bonds traded over the world. These funds have
access to stocks and bonds traded through the active exchanges all over the world.
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3. Vulture Fund – These funds purchase securities from firms in trouble in the hope of earning
exceptional return when the valuable assets are liquidated.
4. Hedge Fund – These funds adopt aggressive strategies and make high risk investment in the hope of
large returns from the investment.
Investors prefer Mutual funds because of three reasons:
1. Mutual funds have greater price stability of the shares that is market risk is low because funds are
invested in high quality instruments.
2. Funds have opportunities to the capital gain.
3. As mutual funds are invested in the money market, they have high liquidity.
Tax benefits of Mutual funds: Mutual funds have favorable tax situations. They pay no taxes on income
provided that –
1. At least 50% of total resources must be invested in securities.
2. They must maintain a highly diversified security investment. No more than 25% of total resources
can be invested in securities issued by a single firm.
3. At most 10% of the earnings can be retained in the company, and the rest must be distributed to the
shareholders.
Types of Mutual Funds:
1. Open End Mutual Funds – They can sell shares in any quantity demanded by the public.
2. Close End Mutual Funds – They can sell only a specific number of shares. They can raise funds by
selling preferred stocks and convertible bonds. These shares are traded in the stock exchange.
Three Major Objectives of Mutual Funds:
1. Growth Objective – Mutual funds invest mainly in common stocks offering strong growth potential to
achieve long term capital appreciation.
2. Income Objective – Mutual funds purchase stocks and bonds paying high dividends and interests to
gain current income.
3. Balanced Objective – Mutual funds acquire bonds, preferred stocks, and common stocks that offer
both capital gain and current income. Bonds and preferred stocks offer current income, and common
stocks offer capital gain.
Finance Companies: They are sometimes called the departmental store of business and consumer credits
and they make loans to businesses and consumers for variety of purposes.
Three Types of Finance Companies:
1. Consumer Finance Companies – They make personal loans for the purchase of automobiles, home
appliances, mobile phones, and also for meeting expenses for health care, education, home repair,
utility bills, and vacations.

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2. Sales Finance Companies – They provide loans to customers of selected dealers or companies
selling automobiles, and other consumer durables. The main objective is to promote sales of
sponsoring firm product by providing loan to customers.
3. Commercial Finance Companies – They focus mainly on providing loans to business firms for the
purchase of productive resources that can generate income, for the purchase of aeroplanes,
automobiles, and equipments.
Sources of Borrowed Funds for Finance Companies: In addition to the shareholders’ funds, finance
companies use heavy debt in financing their operations. Principal sources of borrowed funds are –
1. Bank loans
2. Commercial papers
3. Bonds sold to corporations, insurance companies, and pension funds
Mortgage Banks: They mainly invest in mortgage loans for the construction of apartment buildings,
office buildings, and commercial structures. They sell shares to long term lenders like insurance
companies and pension funds. Other sources of income are mortgage interests, and sale of properties.

Lecture 18 / Apr 23, 2009

Life Insurance Companies: They collect funds from the policyholders by offering protection against the
risk of earning losses that follows death, disability, or retirement. In return, LICs receive premiums from
policyholders. LICs require additional funds to meet policyholders’ claims and other operating expenses.
And to earn additional funds, LICs make long term investment.
Types of Life Insurance Policy:
1. Whole Life Insurance Policy – It covers the entire life time of the policyholders. Beneficiaries
receive benefit payments after the death of the policyholders. Another name of this insurance policy
is ordinary policy.
2. Term Life Insurance Policy – It covers a certain number of years and beneficiaries receive benefit
payments if the death occurs within the period of coverage.
3. Endowment Life Insurance Policy – Benefits are payable to the living policyholders on a specified
future date. This policy generally has a higher premium than that of ordinary policy for the same
amount of insurance, because majority portion of the premium is devoted to increase the cash value.
4. Group Life Insurance Policy – It covers a group of people working for the same employer, or
members of the same organization.
5. Universal Life Insurance Policy – It is a type of term policy that is renewed each year and it has
some flexibility for the policyholders. It allows the policyholders to change the amount of insurance
and policy premium.

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6. Variable Life Insurance Policy – It allows the policyholders to invest a portion of the premium in
various instruments within the investment portfolio such as bonds, stocks, and money market funds.
So the cash value and the end benefit of this policy are determined by the success of this investment.
7. Credit Life Insurance Policy – This policy is bought by the borrowers, and insurance company will
pay out the debt if the borrower dies while the policy is in force.
8. Health Insurance Policy – It covers medical bills, cost of hospitalization, and possible loss of income
from accident and disease.
Investment Made by LICs:
• Usually they pursue income certainty and safety of principal amount in their investment, because they
hold the public money. They invest the bulk of their funds in long term high ranked corporate
securities. Usually they follow buy and hold strategy, because there is a little or no need of short term
money to meet the claims of the policyholders.
• LIC also provides mortgage loans on residential and commercial properties (shopping centers, office
buildings, apartments, hospitals, and factories).
• LIC purchases government bond, and it provides the liquidity because it can be sold less difficultly
when funds are needed.
• LIC provides loans to policyholders. The policyholders can borrow against their accumulated funds.
Calculation of Premium: Life insurance business is founded upon the law of large numbers – ‘A risk
that is non-predictable for one person can be forecast accurately for a sufficiently large group’.
Number of Policyholders of 40 Years Age = 100,000
Policy Amount per Policyholder = Tk. 100,000
According to the Mortality Table, the expected death of 40 Years Age Next Year
= 0.4% = 400
Expected Claim = 400 * Tk. 100,000 = Tk. 40,000,000
At 10%, PV of Expected Claim = Tk. 40,000,000 / 1.1 = Tk. 36,400,000
Operating Expenses = Tk. 3,000,000 (Assumption)
Total Expense = Tk. 36,400,000 + Tk. 3,000,000 = Tk. 39,400,000
So, Premium = Total Expense / Number of Policyholders of 40 Years Age = Tk. 394

Lecture 19 / Apr 27, 2009

Property / Casualty Insurance Company (PCIC): It is the insurance super market, because it covers a
broad range of risk. It offers protection against damages of properties from fire, bad weather, or any other
natural disaster. It covers the risk of individuals from accident, and the risk of property from theft. Many
PCICs offer health and medical policies.
Factors Affecting PCIC Business:

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1. Inflation has the impact in the cost of properties and services for which premium is paid. For
example, if the cost of medical care or the cost of automobile parts increases, the amount of claims
also increases.
2. Illness or injury caused by exposure to nuclear radiation and other hazardous substances
3. Rise in product or service liability affects PCIC businesses. For example, rise in medical
malpractices, claims against manufacturer of products that cause accident or injuries due to faulty
design or poor workmanship.
Risk Management of PCIC Business:
1. To reduce risk, PCIC diversifies into many different lines of insurance
2. PCIC contracts with other companies to share some of the risk, and also share premiums.
Differences between LIC and PCIC:
1. PCIC business is riskier business than LIC business. LIC is highly predictable business and PCIC
business is less predictable.
2. LIC policies are long term contracts. Claims are not normally expected for several years. PCIC claims
are payable from the day a policy is opened, because accident or injury may occur anytime.
3. LIC can stay almost fully invested, but PCIC must be ready at all times to meet the claims of the
policyholders.
4. LIC pays a policyholder, or the beneficiaries a fixed amount of money, but claims against PCIC are
directly affected by inflation.
5. Like LIC, PCIC can’t make long term investment always. Even though, PCIC can invest in some long
term instruments, such as corporate bonds, government bonds, common stocks that can be converted
into cash quickly.
Pension Funds: They protect individuals and families against loss pf income in their retirement periods.
Employees set aside a portion of their salaries, and the amount is invested in the pension funds.
Types of Plans under Pension Funds:
Benefit Plans – They promise a specific monthly or yearly payment to employees when they retire. And
the amount is based upon the size of salary at the time of retirement, and the length of employment. An
employee who leaves early, or is dismissed before retirement, may get a little, or nothing.
Contributory Plans – This plan is based upon the contribution of the employees. A fixed percentage of
each employee’s salary is contributed to the fund, and the organization contributes the equal amount in
the name of the employee. And the amount to be received when retirement is reached depends on the
amount contributed by the employee and the organization, and returns earned on the accumulated savings.
Employee can take loan from this plan.
Investment of Pension Funds: Pension funds are long term investors because funds have limited needs
for liquidity. Funds are invested in real estate, and long term bonds.

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Drafted by Roll 60, Batch 40E