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Level 18

Role of Financial Intermediation


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Federal Reserve Bank
The Central Bank is also called the
Commercial Banks
Financial institutions that provide services such as accepting deposits, giving business and auto loans, mortgage lending and basic investment products
Direct Finance
Individuals purchase bonds from a business
Indirect Finance
When borrowers and lenders are matched through financial intermediaries
financial intermediation
the process of indirect finance whereby financial intermediaries link lender savers and borrower spenders
Financial Intermediaries
Business that specialize in borrowing funds from people who have saved and lending to people who want to borrow
Asymmetric Information
situation when one party doesn't know enough about the other party to make accurate decisions. This creates two kinds of problems:
Adverse Selection
This happens before the transaction
moral hazard
the risk that one party to a transaction will engage in behavior that is undesirable from the other party's point of view
Larger scale and lower management costs
people can pool funds in an intermediary, reducing costs, risks (pension funds, investment companies, and government-sponsored financial institutions)
Liabilities
amounts owed; the legal claims against a business or household by non-owners; the sources of funds for financial intermediaries
Assets
Accounts receivable, what others owe to you
Balance Sheet
statements of assets and liabilities
fractional reserve banking
a banking system that keeps only a fraction of funds on hand and lends out the remainder
the money multiplier falls
As the Reserve Ratio goes up
The FDIC stands for
Federal Deposit Insurance Corporation
The FDIC is a government insurance that
covers money that you have on a deposit in a bank.
$250,000
The FDIC has up to how much in each bank?
lost a single cent on insured funds
Since the FDIC started in 1934, no depositor has
Collateral
property that is pledged to a lender to guarantee payment in the event that the borrower is unable to make debt payments **this type of debt is secured debt**
Credit risk
possibility that borrower will not meet the scheduled repayments and default on their loan
defined benefit plan
a pension plan where the benefits paid at retirement are specified.
defined contribution plan
a pension plan where the contributions of the employer and the employee are specified and the benefits depend on the performance of the assets in the plan.
Depository Institution
Savings and Loan Associations (S&Ls) and Mutual Savings Banks
Federal Savings and Loan Insurance Corporation
Government agency that provided deposit insurance for savings and loan associations (replaced by the Federal Deposit)
Financial Asset
represents a promise to distribute cash flows at some future time
financial disintermediation
when funds flowing through the intermediated markets are shifted to flowing through the financial (securities) markets.
Financial intermediary
an institution acts as a service for both those who have extra money to save or lend and channels it to those who wish to invest or borrow.
institutionalization
shifts in flow of funds from investors directly purchasing traded securities to indirectly purchasing traded securities through financial intermediaries such as mutual funds.
interest rate risk
the risk that a change in interest rates may affect the net worth of a financial intermediary because of a mismatch in the maturity of its assets and liabilities.
lesser developed country (LDC)
refers to developing countries whose economies and financial systems are still considered immature.
money market deposit account (MMDA)
Deposits with limitied checking account privileges that typically pay an interest rate comparable to Treasury bills or other money market instruments.
money market mutual fund
a fund that pools money from small savers to purchase short-term government and corporate securities
monitoring
Producing and using information about a borrower or issuer after a financial contract's origination.
mutual fund family
a group of mutual funds owned and managed by the same management company.
Mutual savings bank
State-chartered financial institutions operated by trustees for the benefit of depositors.
nondepository financial intermediary
a financial intermediary that does not issue deposits.
nontraded financial contract
A financial claim or contract that cannot be traded in a secondary market but is instead held to maturity by its original investor or lender.
NOW account
an interest bearing checking account.
portfolio diversification
Holding financial instruments
private placement
nontraded corporate bonds that do not have to be registered with the SEC...
Regulation Q
the regulation that imposed ceilings on deposit interest rates. Regulations Q was effectively dismantled in the early 1980s.
savings and loan associations (S&Ls)
Depository institutions that are substantially restricted to investing in home-related assets such as mortgages..
thrift institutions
Savings and loans associations, mutual savings banks, and credit unions are referred to as the thrift institutions.
traded securities
Financial claims or contracts that are traded in a secondary market such as stocks traded on the NYSE.
transaction cost
costs, such as commissions and the bid-asked spread, of buying and selling securities.
Matching Principle
record expenses in the period that the related revanue is recognized
Periodicity
the life of an enterprise can be divided into artificial time periods
Historical Cost Principle
the origional transaction value upon acquisition
Materiality
concerns the relative size of an item and its effect on decisions
Realization Principle
criteria usually satisfied at point of sale
Going concern assumption
the entity will continue indefinitley
monetary unit consumption
a common denomenator is the dollar
economic entity assumption
the enterprise is seperate from its owner and other entities
full disclosure principle
all information that could be divided into artificial time periods
1 prepayments and deferrals
3 catagories of adjusting entries
prepayments and deferrals
pre payment is made prior to expense being incurred
depreciation adjustment
origion dr property and equipt cr cash/accts pay
accruals
dr exp cr liab
estimates
bad debt, warrenties, other reserves
total liabilities/shareholders equity
debt to equity ratio
EBIT/Interest
times interest earned
provisions of sarbanes oxley
Creation of an Oversight Board
ASU No 2014-09
Changes the way that revenue is recognized. Goes into effect on Dec 15 public-2016 private-2017
When do companies recognize revenue?
Companies recognize revenue when goods or services are transferred to customers for the amount the company expects to be entitled to receive in exchange for those goods or services.
Requirements for a contract (5)
Can be implied or contractual
Performace obligations
must be both:
record cost
Journal Entries for % of completion
J/e to record cost
dr construction in process
Dr accouts recievable
J/E to record billings
Dr Cash
J/E to record cash reciepts
J/E ro record revenue/GP
dr construction in process (asset)
dr cost of construction
J/E to record expected loss
Profit Margin
Net Income/Net Sales
Asset Turnover
Net Sales/Total Assets
Equity Multiplier
Total Assets/Shareholders Equity
ROE
Net Income/Shareholders Equity
Current Ratio
Current Assets/Current Liabilities
(Current Assets-Inventory)/Current Liabilities
Quick Ration (Asset Test)
Recievables Turnover
Sales/Accounts Recievables
avg collection period
365/receivables turnover ratio
COGS/Inventory
Inventory Turnover
Times Interest Earned
Earnings before Interest and Tax/Interest Expense
Contract Price
% Completion categories
Record Actual/Estimated Returns:
J/E for Actual Sales Returns
cash equivalents
short term, highly liquid investments w/original maturities of 3 months or less
Bank Reconciliation
reconsile for timing differences between bank and book
book balance
adjusted bank balance/book balance
restricted cash
cash restricted for some purpose (usually contractual by 3rd party)
compensating balances
banks often require a cash transaction with a loan, will require the borrower to maintain a specific balance in a low interest account, some % of the committed amount.
Estimate:
Sales returns J/E estimate
Sales Returns J/E Actual
Actual Returns if estimate is Correct:
Uncollectible Accounts
I/S Approach
bad debt I/s v B/S
I/S- result of estimating bad debt as a % of net credit sales (J/E)
gross
Receivables (gross)
Net
Receivables (net)
trade v cash discount
trade- lower prices without lower list price