Week 10 - NBFIs

Question 1

How do PTP lending platforms reduce information asymmetry?

Answer 1

Give ratings (e.g. A-D) to deficit units

Question 2

What are some types of screening provided by PTP lending platforms?

Answer 2

• Borrower ratings
• Monitoring functionality

Question 3

When & why did PTP lending gain popularity?

Answer 3

After GFC due to:
- loss of faith in banks
- less lending by banks

Question 4

What is the advantage of PTP lending for surplus units?

Answer 4

Higher returns

Question 5

What is the disadvantage of PTP lending for surplus units?

Answer 5

No deposit insurance

Question 6

How does PTP lending differ from banking?

Answer 6

Involves some intermediation, but contract is directly between lender + borrower

Question 7

What are examples of NBFIs?

Answer 7

1. Insurers
2. Pension funds
3. Finance companies/houses
4. Securities houses
5. Mutual funds
6. OFIs

Question 8

What is insurance for?

Answer 8

Protecting individuals & their beneficiaries from income loss due to premature death/retirement

Question 9

How does insurance work?

Answer 9

Pools risk to transfer income uncertainty from individual to group

Question 10

How are insurers funded?

Answer 10

Collect premiums to invest in the financial market

Question 11

What kind of interest rate risk affects insurers?

Answer 11

Reinvestment risk – suffer if rates fall

Question 12

Why might insurers invest in property?

Answer 12

Hedge against inflation

Question 13

What are the main types of life insurance?

Answer 13

1. Term
2. Whole
3. Endowment
4. Variable

Question 14

How does term life insurance work?

Answer 14

• No savings element
• Pays if you die in the term

Question 15

How does whole life insurance work?

Answer 15

• Savings element
• Covers whole lifetime

Question 16

How does endowment life insurance work?

Answer 16

• Savings element
• Pays if you die in the term
• Pays unit-linked face value if you survive term

Question 17

How does variable life insurance work?

Answer 17

• Invests in mutual funds
• Value depends on asset returns

Question 18

What do insurers mostly invest in?

Answer 18

Long-term government bonds & equities

Question 19

True or false: in some countries, pension AUM > GDP

Answer 19

True

Question 20

How much is pension AUM globally?

Answer 20

$35.4 trillion

Question 21

What can happen when a stock is downgraded?

Answer 21

Institutional investors are forced to sell en masse

Question 22

What type of interest rate risk affects insurers?

Answer 22

Reinvestment risk

Question 23

What are an insurer’s liabilities?

Answer 23

Policy reserves i.e. expected payment commitment on existing policies

Question 24

What are policy reserves based on?

Answer 24

Actuarial assumptions

Question 25

Besides interest rate risk, what other risks affect insurers?

Answer 25

- Actuarial risk (fluctuations in payouts) - Financial risk (fluctuations in rate of returns on portfolio)

Question 26

Why regulate insurers?

Answer 26

1. Prevent deceptive sales practices 2. Ensure solvency 3. Limit market power / cartels / high premiums 4. Prevent unfair discrimination

Question 27

What is the prudential regulation for insurers?

Answer 27

Solvency II, based on Basel II

Question 28

How do insurers manage risk?

Answer 28

Reinsurance

Question 29

What was the main pre-pandemic challenge for the insurance industry?

Answer 29

Low interest rates -> diversifying into credit, commodities, real estate, PE, indexed bonds

Question 30

What is the main post-pandemic challenge for the insurance industry?

Answer 30

Rapid increase in interest rates -> lowers value of long-term bonds

Question 31

What is an ongoing challenge for the insurance industry?

Answer 31

Competition from 'InsurTech' firms

Question 32

What is 'private debt'?

Answer 32

- Loans from banks - New asset class popular with insurers

Question 33

What is the pension system in most countries?

Answer 33

3 pillars: 1. State pensions 2. Workplace pensions 3. Private pensions

Question 34

How can you tell a private pension from any other investment product?

Answer 34

Requirement to retire before accessing money

Question 35

What are the main types of pensions?

Answer 35

- Defined benefit - Defined contribution

Question 36

True or false: DB pensions may require variable contributions

Answer 36

True

Question 37

With a DC pension, what dictates value of payout?

Answer 37

Value of portfolio

Question 38

True or false: DC pensions allow individuals to choose their asset allocation

Answer 38

True

Question 39

What is the aim of pension regulation?

Answer 39

- Avoid mis-selling - Promote disclosure - Capital adequacy

Question 40

How do finance companies/houses raise funds?

Answer 40

Issuing securities on capital market

Question 41

What are capital market securities?

Answer 41

- Short-term notes - Commercial paper

Question 42

True or false: finance companies/houses are subject to more regulation than other FIs

Answer 42

False. No deposits = less regulation

Question 43

What is the benefit of a finance company/house for its parent company?

Answer 43

Diversifies revenues

Question 44

What are the main (overlapping) types of finance companies/houses?

Answer 44

1. Sales finance institutions 2. Personal credit institutions 3. Business credit institutions

Question 45

How do personal credit institutions differ from banks?

Answer 45

- Lend to riskier customers - Collateral that banks would reject - Higher rates

Question 46

What advantages do sales finance institutions have over banks?

Answer 46

- Convenient access to customers - Faster approvals - Higher approval ratios - Lower rates - Lower fixed costs

Question 47

How do business credit institutions work?

Answer 47

Buy accounts receivable at a discount & take responsibility for collection

Question 48

What takes the place of regulation for finance companies/houses?

Answer 48

Market monitoring i.e. low-quality loans = less funding from market

Question 49

What are securities firms?

Answer 49

Essentially investment banks without the banks

Question 50

What do securities firms do?

Answer 50

Design, issue & trade securities

Question 51

What are assets for a securities firm?

Answer 51

- Reverse repos - Receivables from other brokers - Security/commodity longs

Question 52

What are liabilities for a securities firm?

Answer 52

- Repos - Limited equity

Question 53

What do mutual funds provide?

Answer 53

Greater diversification than an individual investor can achieve alone

Question 54

What is the 2nd biggest type of FI in the US by asset size?

Answer 54

Mutual funds

Question 55

True or false: mutual funds can be open- or closed-ended

Answer 55

True

Question 56

What does MMMF stand for?

Answer 56

Money market mutual fund

Question 57

What do MMMFs have in common with bank deposits?

Answer 57

- Liquid - Safe - Short-term - Open-ended

Question 58

True or false: in the US, you can write cheques on MMMFs

Answer 58

True

Question 59

Why have bank deposits been declining since the 70s?

Answer 59

Money put into MMMFs

Question 60

What are the main types of US MMMFs?

Answer 60

- Prime MMMFs - Government MMMFs

Question 61

What are prime MMMF investments?

Answer 61

Corporate debt securities

Question 62

What are government MMMF investments?

Answer 62

- Government securities - Govt security-backed repos - Cash

Question 63

What are hedge funds?

Answer 63

A type of mutual fund

Question 64

What type of strategies do hedge funds use?

Answer 64

- Riskier - More sophisticated - Proprietary

Question 65

What is a typical minimum investment for a hedge fund?

Answer 65

$1million+

Question 66

What is the regulatory limit on hedge fund fees?

Answer 66

None

Question 67

What characterises hedge fund investors?

Answer 67

Too wealthy to worry about liquidity & stability