Chapter 2

Financial Institutions,
Financial
Intermediaries and
Asset Management
Firms
1

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Services of Financial
Institutions
Transforming Financial Assets
Exchanging Financial Assets on Behalf

of Customers
Exchanging Financial Assets for Own
Account
Assisting in the Creation of Financial
Assets
Providing Investment Advice
Managing Portfolios
2

Copyright 2010 Pearson Education, Inc. Publishing

Role of Financial
Intermediaries

Transfer of funds from savers to

investors
Types of Investments
Direct Investment
For example, purchasing a portfolio of
stocks and bonds
Indirect Investment
For example, purchasing an equity

claim issued by an investment company

3

Copyright 2010 Pearson Education, Inc. Publishing

Role of Financial
Intermediaries
Providing Maturity Intermediation
Reducing Risk Through

Diversification
Reducing Costs of Contracting
and Information Processing
Providing a Payments Mechanism

Copyright 2010 Pearson Education, Inc. Publishing

Role of Financial
Intermediaries
Providing Maturity

Intermediation
Reducing Risk via Diversification
Reducing Costs of Contracting
and Information Processing
Providing a Payments
Mechanism
5

Copyright 2010 Pearson Education, Inc. Publishing

Asset/Liability Management
Spread and Non-Spread

Businesses
Nature of Liabilities
Amount of cash outlay
Timing of cash outlay

Liquidity Concerns
Regulations and Taxation
6

Copyright 2010 Pearson Education, Inc. Publishing

Nature of Liabilities of Financial

Institutions
Amount of Cash
Outlay

Timing of Cash
Outlay
Known

Type II

Known
7
Known

Uncertain

Type III

Uncertain

Known

Type IV

Uncertain

Uncertain

Liability Type
Type I

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Concerns of Regulators
Credit Risk
Settlement Risk
Counterparty Risk
Liquidity Risk
Market Liquidity Risk
Funding Liquidity Risk

Market Risk
Operational Risk
8

Copyright 2010 Pearson Education, Inc. Publishing

Asset Management Firms

Ranked by assets under management

Copyright 2010 Pearson Education, Inc. Publishing

Fees and Compensation

Fee structure
Fee based on assets under

management
Performance-based fee

10

Copyright 2010 Pearson Education, Inc. Publishing

Types of Funds Managed

Regulated investment

companies
Insurance company funds
Separately managed accounts
Pension funds
Hedge funds

11

Copyright 2010 Pearson Education, Inc. Publishing

Hedge Funds
No single definition of hedge

fund
George Soros
Presidents Working Group on

Financial Markets
U.K. Financial Services Autority

12

Copyright 2010 Pearson Education, Inc. Publishing

Hedge Fund Characteristics

Hedge is misleading
Wide range of trading

strategies
Leverage, short selling, arbitrage,

risk control

Operate in all financial markets

Focus on absolute returns
Lastly, funds cater to

sophisticated investors

13

Copyright 2010 Pearson Education, Inc. Publishing

Types of Hedge Fund

Market directional hedge fund
Corporate restructuring hedge

fund
Convergence trading hedge
fund
Opportunistic hedge fund

14

Copyright 2010 Pearson Education, Inc. Publishing

Concerns with Hedge Fund

Hedge funds provide market

benefits
Liquidity
Market pricing efficiency

However, there are concerns

System risk
Long-Term Capital Management
Bear Stearns
Market meltdown of 2008
15

Copyright 2010 Pearson Education, Inc. Publishing

All rights reserved. No part of this publication may be reproduced,

stored in a retrieval system, or transmitted, in any form or by any means,
electronic, mechanical, photocopying, recording, or otherwise, without
the prior written permission of the publisher. Printed in the United
States of America.

16

Copyright 2010 Pearson Education, Inc. Publishing