Chapter 4 Flashcards
(35 cards)
What is maturity transformation?
Borrowing short term and lending long term
What has been at the root of numerous banking crises?
The fractional reserve system
What is direct financing
Financing without using a intermediary
What are the four limitations of direct financing?
It is limited by amount of gold that is available and how much people are willing to lend
Requires credit assessment and risk pricing
Ties up a lender’s money until final repayment of a loan
Lender has to apply to courts for redress if principal and interest are not paid. (Expensive and difficult)
What is settlement finality?
Transaction settlement that cannot be rescinded
Instead of exchangeability into gold what three things do we look for from a central bank?
That the currency of a country will be accepted by everyone in the country for the exchange of goods and services
That it’s value throughout time will not decline to an unacceptable rate
That it’s value in international trade will not decline
What are the two roles of currency?
Unit of account -to allow things to be priced relative to each other
Medium of exchange- to facilitate transactions
What do investment banks have?
A banking license which permits
What are the two main divisions of the investment bank?
Corporate finance- the investment banking side (arranges securities issues)
Investor facing -the brokers and dealers
What do principle activities involve?
Using their own capital for generating profit or loss directly without providing client services
Three product divisions in investment bank?
Corporate finance
Securities and trading sales
Asset management
What does ring fencing mean?
Retail banking on the on the one hand and investment banking on the other would have to be undertaken by separate companies with separate management and with separate capital and liquidity to support them.
What do the broker and dealer do?
The broker undertakes sales while the dealer makes markets
To minimise risk, what are the three offices trading and sales are divided into?
The front office- trading floor
Middle office- providing risk measurement and management
Back office- ensures trades are cleared and settled
What does the trading function provide?
The means for holders of financial assets to turn their securities into cash or vise versa (basically provision of liquidity)
What is financial risk?
The risk of loss in the value of financial instruments
What is hedging ?
Hedging means reducing one’s exposure to financial risk by eliminating the risk of a downside price movement.
What does a forward contract commit?
The buyer of the contract to buy a specified quantity of an asset on a specific date for a specific price
What type of contracts are forward contracts?
Derivative contracts
What is an example of a forward contract?
Natural hedge
What are the two motives for entering a derivative contract?
A hedger
A speculator
What is diversification?
A key means of reducing risk
In medieval times, banks originally provided only what?
Safekeeping of funds
A commercial bank is what?
A principle business
