Chapter 13 Nonbank Finance
Insurance Life insurance Permanent (whole, universal, and variable) Term Property and Casualty Hold more liquid assets than life insurance companies Reinsurance
Insurance (cont’d) Competitive threat from the banking industry Credit insurance Credit default swaps AIG case. Monoline insurance
Table 1 Relative Shares of Total Financial Intermediary Assets, 1970–2008 (percent)
Insurance Management To lower moral hazard and adverse selection Screening Risk-based premiums Restrictive provisions Prevention of fraud Cancellation of insurance Deductibles Coinsurance Limits on the amounts of insurance
Pension Funds Defined-contribution plan Defined-benefit plan Fully-funded; underfunded Private pension plans Employee Retirement Income Security Act (ERISA) of 1974 Pension Benefit Guarantee Corporation (PBGC, Penny Benny)
Pension Funds (cont’d) Public pension plans Social Security Pay as you go system. Massive underfunding. Possible reforms proposed.
Finance Companies Virtually unregulated compared to commercial banks and thrifts institutions Sales finance companies Consumer finance companies Business finance companies Factoring Leasing equipment
Securities Market Operations Financial facilitators Investment banks Securities brokers and dealers Organized exchanges
Investment Banking Assist in the sale of securities Advise the corporation on whether it should issue bonds or stock. Bonds: advise on maturity and interest payments Stocks: advice on price Seasoned issues or initial public offering Underwrites
Investment Banking (cont’d) Regulated by SEC Registration statement Provide potential investors with a prospectus 20 day waiting period
Securities Brokers and Dealers Securities brokers and dealers conduct trading in secondary markets Brokers Agents for investors, match buyers and sellers Paid brokerage commission Dealers Stand ready to buy and sell Hold inventories Paid by the ‘spread’ Brokerage firms Act as brokers, dealers, and investment bank Regulated by SEC
Organized Exchanges NYSE: largest organized exchange in the world. Hybrid of auction market and dealer market. Specialist Regulated by SEC Authority to impose regulation and to alter the rules set by the exchanges Securities Amendments Act of 1975 Growing internationalization
Mutual Funds Pool the resources of many small investors by selling shares and using the proceeds to buy securities Sovereign wealth funds Estimated to hold $3 trillion in assets Concerns Size (can cause market instability) National security issues Provide very little information about their operations Open-end fund and closed-end fund
Mutual Funds (cont’d) Load funds and no-load funds Regulated by Securities and Exchange Commission Money market mutual funds Function as checkable deposits that earn interest.
Hedge Funds Similar to mutual funds but: Minimum investment typically $1 million No more than 99 investors Net worth requirement for investors Long-term commitment Speculates on spreads
Private Equity and Venture Capital Funds Private equity fund Long-term investments in companies that are not traded in public markets. Two types Venture capital funds Capital buyout funds (leveraged buyout) Carried interest
Government Financial Intermediation Mortgage market GNMA, Ginnie Mae FNMA, Fannie Mae (GSE) FHLMC, Freddie Mac (GSE) Farm Credit System Federal Credit Reform Act of 1990 The creation of GSEs has led to conflict of interest and moral hazard problems.