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Chapter 2 Financial Assets, Money, Financial Transactions, and Financial Institutions Learning Objectives  

You will see the most important channels through which funds flow from lenders to borrowers and back again within the global system of money and capital markets. You will discover the nature and characteristics of financial assets-how they are created and destroyed by decision makers within the financial system. You will explore the critical roles played by money within the financial system and the linkages between money and inflation in the prices of goods and services. You will examine the important jobs carried out by financial intermediaries in lending and borrowing and in creating and destroying financial assets.

 

Key Topics Outline         

Financial Assets: What Are They? What Are Their Features? Balance-Sheet Identities: Assets, Liabilities, and Net Worth. Deficit- and Surplus-Budget Units. Money: What Is It? What Are Its Principal Functions? Inflation, Deflation, and Money: Thinking in Real Terms. Types of Financial Transactions: Direct, Semidirect, and Indirect. Financial Intermediation and Types of Financial Institutions. The Disintermediation and Reintermediation of Funds The Bank-Dominated VS. Market-Dominated Financial Systems.

Chapter Outline 2.1. 2.2. 2.2.1. 2.2.2. 2.3. 2.4. 2.5. 2.6. 2.6.1. 2.6.2. 2.6.3. 2.7. 2.7.1. 2.7.2. 2.7.3.

Introduction: The Role of Financial Assets The Nature and Characteristics of Financial Assets Characteristics of Financial Assets Types of Financial Assets How Financial Assets Are Created Financial Assets and the Financial System Lending and Borrowing in the Financial System Money as a Financial Asset What Is Money? The Functions of Money The Value of Money and Other Financial Assets and Inflation The Evolution of Financial Transactions Direct Finance Semidirect Finance Indirect Finance and Financial Intermediation

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2.8.

Relative Sizes and Types of Major Financial Institutions 2.8.1. Comparative Sizes of Key Financial-Service Providers 2.8.2. Classifying Financial Institutions 2.8.3. Portfolio (Financial-Asset) Decisions by Financial Institutions 2.9. The Disintermediation of Funds 2.9.1. New Types of Disintermediation 2.10. Bank-Dominated versus Market-Dominated Financial Systems

Key Terms Appearing in This Chapter financial asset, 26

nominal value, 40

money, 27

direct finance, 41

equities, 27

semidirect finance, 41

debt securities, 27

indirect finance, 42

derivatives, 27

reintermediation, 47

internal financing, 28

secondary securities, 42

external financing, 29

primary securities, 42

deficit-budget unit (DBU), 34

depository institutions, 45

surplus-budget unit (SBU), 34

contractual institutions, 45

balanced-budget unit (BBU), 34

investment institutions, 45

inflation, 38

disintermediation, 47

deflation, 38

bank-dominated financial systems, 48

price indexes, 38

market-dominated financial systems, 48

real value, 40

Questions to Help You Study 1. Exactly what do we mean by the term financial asset? Answer: A financial asset is a claim against the income or wealth of a business firm, household, or unit of government, represented usually by a certificate, receipt, computer record file, or other legal document, and usually created by or related to the lending of money. Examples include bonds, stocks, insurance policies, futures contracts, and deposits held in a bank or credit union. 2. How do financial assets come about within the functioning of the financial system? Answer: Financial assets arise in the process of borrowing and lending money, or are related to such processes (e.g., derivatives). Any time funds are borrowed (or stock is issued) a financial asset is created which represents a claim against the future earnings or wealth of the borrowing unit.

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3. Carefully explain why the volume of financial assets outstanding must always equal the volume of liabilities outstanding. Answer: Because another definition of financial asset is any asset held by a business firm, government, or household that is also recorded as a liability or claim on some other economic unit’s balance sheet is a financial asset. The act of borrowing or of issuing new stock simultaneously gives rise to the creation of an equal volume of financial assets. For example, a $10,000 financial asset held by a household that had lent money will be exactly matched by a $10,000 liability of the business firm that had borrowed the money. Hence, it follows that the volume of financial assets outstanding must equal the volume of liabilities. 4. What is the difference between internal finance and external finance? Answer: In internal finance, both the household and the business firm use the current income and accumulated saving to acquire assets (self-financed). In external finance, the firm will issue the financial liabilities to raise additional funds to the household securities evidencing a loan of money. 5. When a business, household, or unit of government is in need of additional funding, what are its principal alternatives? What factors should these different economic units consider when they have to choose among different sources of funds? Answer: For any economic unit the principal alternatives for raising funds include: (1) accumulate savings (internal financing), (2) sell off existing assets, (3) borrowing, or (4) issue new stock. Accumulate saving approach take some times. Firms may need to postpone the equipment purchase that will result in lost sales and lost profits. Selling some existing assets may take time, and there is a risk of substantial loss, especially if fixed assets must be sold. Borrowing has an advantage of raising the funds quickly, and the interest cost on a loan is tax deductible. For issuing new stock, firms need to take on debt, and the cost of equity financing is often more expensive than borrowing and requires more time to arrange. 6. What is the relationship between the process of creating financial assets and liabilities and the acts of saving and investment? Why is that relationship important to your financial and economic well-being? Answer: For the balance sheet of any economic unit, Total assets = Total liabilities + Net worth, where total assets = real assets + financial assets. For the whole economy and financial system, Total financial assets = Total liabilities. So, for the economy as a whole, Total real assets = Total net worth (i.e., accumulated savings). Society increases its wealth only by saving and increasing the quantity of its real assets (investment), for these assets enables the economy to produce more goods and services in the future. However, the financial system provides the essential channel necessary for the creation and exchange of financial assets between savers and borrowers so that real assets can be acquired. Without that channel for savings, the total volume of investment in the economy will be greatly reduced, and society's scarce resources will be allocated less efficiently than is possible with a system of financial markets. Growth in society's income, employment, and standard of living will be seriously impaired without a vibrant global financial system at work.

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7. What do the following terms mean? Deficit-budget unit (DBU) Surplus-budget unit (SBU) Balanced-budget unit (BBU) Answer: Let R = Current income receipts, E = Expenditures out of current income,  FA = Change in holdings of financial assets, and  D = Change in debt and equity outstanding. The Deficit-budget unit (DBU) (net borrower of funds) is a net demander of funds from the financial system, selling financial assets, issuing new debt, or selling new stock to raise new money: E > R and  D >  FA. The Surplus-budget unit (SBU) (net lender of funds) is a net supplier of funds to the financial system, purchasing financial assets, paying off debt, or retiring equity (stock): R > E and  FA >  D. The Balanced-budget unit (BBU) is neither net lender nor net borrower: R = E and  D =  FA. 8. Which were you last year a deficit-, surplus-, or balanced-budget unit? Why is it important to know? Answer: These concepts are important because it enables us to understand how the global financial system permits businesses, households, and governments to adjust their financial position from that of net borrower (DBU) to net lender (SBU) and back again, smoothly and efficiently. It is important to know our status, so that we may take corrective actions if we desire another status. 9. Explain what money is. What are its principal functions within the system of money and capital markets? within the economy? Answer: Money is any financial asset that is generally accepted in payment for the purchases of goods and services. Examples include currency and checking accounts. Within the system of money and capital markets, all financial assets are valued in terms of money, and flows of funds between lenders and borrowers occur through the medium of money. Within the economy, 1. Money serves as a standard of value (or unit of account) for all goods and services. 2. Money serves as a medium of exchange, such that buyers and sellers no longer need to have an exact coincidence of wants in terms of quality, quantity, time, and location. 3. Money serves as a store of value – a reserve of future purchasing power – although the value of money can experience marked fluctuations. 4. Money functions as the only perfectly liquid asset. It exhibits price stability, ready marketability, and reversibility. 10. Does money have any serious limitations as a financial asset? What are these limitations?

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Answer: Yes, money has serious limitations as a financial asset within the financial system. Money tends to carry the lowest rate of return. One measure of the cost of holding money is the income forgone by the owner who fails to convert his or her money balances into more profitable in investments in real or financial assets. Another limitation is the value of money (purchasing power). The value of money changes due to inflation or deflation in the economy. 11. Can you distinguish between inflation and deflation? What do they have to do with money, if anything? Answer: Inflation refers to a rise in the average price level of all goods and services. The opposite of inflation is deflation, where the average level of prices for goods and services actually declines. Inflation decreases the value or purchasing power of money and is a special problem in the financial markets because it can damage the value of financial contracts. Deflation increases the value or purchasing power of money and benefits those whose income doesn’t also decline with price, therefore they can buy more goods and services than they could in the past. 12. Would you expect to find a relationship between money supply growth and inflation or deflation? What kind of relationship? Answer: Yes, there is a relationship. The quantity theory of money is a theory asserting that the quantity of money available determines the price level and that the growth rate in the quantity of money available determines the inflation rate. Money supply Value of Money High

Price Level Low A 

Low 0

B  Money demand High

Quantity of Money

M

When the central bank increases the supply of money, the money supply curve shifts as shown in the diagram above. The value of money then decreases (i.e. the price level increases – inflation occurs) so that supply and demand can reach a balance. The equilibrium moves from point A to point B. Hence, when monetary growth exceeds the amount needed to support sustainable growth in economic activity (an upward shift in the money demand curve), prices will rise. 13. What is direct finance? Semidirect finance? Indirect finance? Answer: Direct finance: Borrower and lender meet each other and directly exchange funds (loans of spending power for an agreed-upon period of time) in return for financial assets (primary securities in the form of stocks, bonds, notes, etc., evidencing direct claims against borrowers) without the help of a third party to bring them together.

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Semidirect finance: Direct lending with the aid of market markers (such as security brokers, dealers, and investment bankers) who assist in the sale of direct claims against borrowers by bringing SBU and DBU units together for fees and commissions. Indirect finance: Financial intermediaries (commercial banks, insurance companies, credit unions, mutual funds, finance companies, pension funds) issue securities of their own (secondary securities – indirect claims against the ultimate borrowers in the form of deposits, insurance policies, retirement savings accounts, etc.) to the ultimate lenders and at the same time accept IOUs from borrowers (primary securities – direct claims against the ultimate borrowers in the form of loan contracts, stocks, bonds, notes, etc.). 14. In the evolution of the financial system, which do you think came first direct, indirect, or semidirect finance? Why do you think this is so? Answer: Most financial systems in history started out using direct finance, since it is the simplest method of carrying out financial transactions that satisfy the needs of savers and borrowers. 15. What are the essential differences between primary and secondary securities? Why are these instruments important to the operation of the financial system? Answer: Primary securities: direct claims against the ultimate borrowers in the form of loan contracts, stocks, bonds, notes, etc. Secondary securities: indirect claims against the ultimate borrowers issued by financial intermediaries in the form of deposits, insurance policies, retirement savings accounts, etc. Both primary and secondary securities are financial assets. In the financial system, they are the instruments that are created and exchanged between savers and borrowers so that real assets can be acquired. Being direct claims against the ultimate borrowers, primary securities are essential to all methods of finance. Secondary securities, on the other hand, permit a given amount of saving in the global economy to finance a greater amount of investment than would have occurred without the presence of intermediation. This is so because intermediation makes saving and borrowing easier and safer – secondary securities generally carry low risk of default, can be acquired in small denominations, and are mostly liquid. 16. In what different ways are financial institutions classified or grouped? Why are such classifications or groupings important in helping us understand what different financial institutions do and what kinds of financial assets they prefer to hold? Answer: Depository institutions derive the bulk of their loanable funds from deposit accounts sold to the public. Examples include commercial banks, savings and loan associations, savings banks, credit unions. Contractual institutions attract funds by offering legal contracts to protect the saver against risk. Examples include insurance companies, pension funds. Investment institutions sell shares to the public and invest the proceeds in stocks, bonds, and other assets. Examples include investment companies, money market funds, real estate investment trusts.

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Since there are so many types of financial institutions (commercial banks, insurance companies, etc.) in the financial system today, grouping them according to what their distinctive function is greatly help us understand what they do and hence what kinds of financial assets they prefer to hold. Note that the above three groupings apply to financial intermediaries. Other financial institutions include security brokers and dealers, central banks, regulatory institutions, etc. 17. Which financial institutions are the largest within the financial system? Why do you think this is so? Answer: In most countries, banks are the dominant financial institution. This is because most goods and services are paid for using money, and banks, being the primary depositary institution, have developed extensively to facilitate payments (checking accounts, direct deposits, preauthorized payments, letters of credit, banker's acceptances, etc.). So, most households, businesses, and units of government have bank accounts holding most of their working capital. Moreover, bank deposits are relatively safe and liquid (although money is not always a good store of value and the return is usually relatively low), such that savings usually accumulate in bank accounts first before they are invested elsewhere. And due to risk aversion, lack of time, inertia, or inadequate investment knowledge, the amount of such savings can be quite substantial. 18. What factors influence the particular financial assets each financial institution acquires? Answer: The factors influence the particular financial assets each financial institution acquires are: 1) the relative rate of return and risk, 2) the cost, volatility, and maturity of incoming funds, 3) the size of the individual financial institution, and 4) regulations and competition. 19. What is disintermediation and why is it important? How has discrimination changed in recent years? What is meant by the term reintermediation? Answer: Disintermediation means the withdrawal of funds from a financial intermediary by the ultimate lenders (SBUs) and the lending of those funds directly to the ultimate borrowers (DBUs). In other words, disintermediation involves the shifting of funds from indirect finance to direct and semidirect finance. Disintermediation forces a financial institution to surrender funds, and if severe, may lead to losses of its assets and ultimate failure. In recent years some banks have sold off some of their loans because of difficulties in raising enough capital and some of their largest borrowing customers have learned how to raise their funds directly from the open market rather than borrowing from financial intermediary. Reintermediation is the disintermediation that reverses itself as funds flow back into the perceived “safe heaven� of financial intermediaries. 20. Explain the difference between a bank-dominated financial system and a market-dominated financial system. What trends in the structure of the financial system appear to be ongoing in more highly developed economies around the world?

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Answer: In bank-dominated financial systems, banks play the prominent role in supplying credit and attracting savings. In market-dominated financial systems, traditional financial intermediaries are gradually playing somewhat lesser roles and growing numbers of borrowers (particularly the largest corporations) are selling securities (such as stocks and bonds) in the open market to get the funds they need. The trends in the structure of financial systems are leading toward more marketdominated oriented than the bank-dominated financial systems in the developed economies. With the emergence of market-dominated systems there may be greater competition to attract the public’s savings, higher returns for savers, increased competition among lenders, and more funds available to loan.

Problems and Issues 1. In a recent year, the various sectors of the economy listed below reported the following net changes in their financial assets and liabilities (measured in billions of dollars): Net Acquisitions of Financial Assets Households Farm businesses Nonfarm noncorporate businesses Nonfinancial corporations State and local governments U.S. government Foreign individuals and institutions Federal Reserve System Commercial banking Private nonbank financial institutions

$434.6 2.7 8.7 84.9 74.8 13.0 150.7 32.0 256.0 556.9

Net Increase in Liabilities $292.0 -2.5 35.0 127.8 60.6 236.3 29.0 31.2 245.7 590.7

Using these figures, indicate which sectors were deficit-budget sectors (DBUs) and which were surplus-budget sectors (SBUs) for the year under study. Were there any balanced-budget sectors (BBUs)? Which sectors were the largest net lenders and the largest net borrowers during the year? For all these sectors combined, were more funds loaned or more funds borrowed? Why do you think there is a discrepancy between the total funds loaned and total funds borrowed? ANSWER: The following sectors are deficit-budget sectors, because net increase in liabilities exceeds net acquisitions of financial assets: Nonfarm noncorporate businesses, Nonfinancial corporations, U.S. government, and Private nonbank financial institutions. The following sectors are surplus-budget units, because net acquisitions of financial assets exceed net increase in liabilities: Households, Farm businesses, State and local governments, foreign individuals and institutions, and Commercial banking. The Federal Reserve System could be classified as balanced-budget sector given that the difference is so small.

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The largest net lenders are the households and the largest net borrowers are U.S. government. More funds appear to have been borrowed ($1,645.8 billion) than loaned ($1,614.3 billion). This discrepancy is probably due to incomplete (omitted groups and statistical discrepancies) or incorrect reporting of financial transactions, especially those of foreign individuals and institutions. 2. In this chapter, a number of different types of financial transactions were discussed: direct finance, semidirect finance, indirect finance (intermediation), disintermediation, and reintermediation. Examine each of the following financial transactions and indicate which type it is. (Note: Some of the transactions described below involve more than one type of financial transaction. Be sure to identify all types of transactions involved.) a. Borrowing money from a bank: Indirect finance b. Purchasing a life insurance policy: Indirect finance c. Selling shares of stock through a broker and returning the proceeds of the sale to your checking account: Reintermediation and Semi-direct finance d. Withdrawing money from a savings deposit account and lending it to a friend: Disintermediation and direct finance e. Selling shares of stock to a colleague at work: Direct finance f. Your corporation's contracting with an investment banker to help sell its bonds: Semi-direct finance g. Writing a bank check to purchase stock from your broker: Disintermediation and semi-direct finance 3. ITT Corporation in the most recent period reported current sales receipts of $542 million, current operating expenditures of $577 million, and net new debt issued of $5 million. What change in holdings of financial assets must have occurred over the period? Was ITT a deficit-, surplus-, or balancedbudget unit in the most recent period? Explain why. ANSWER: Current Operating Expenditures = $577 million, Current Sales Receipts = $542 million, and Net New Debt issued = $5 million. Because: R - E = FA - D $542 - $577 = FA - $5 And: FA= $5 - $35 = - $30 million Because current operating expenditures exceed current receipts by $35 million, ITT was a deficit-budget unit (DBU) in the most recent period. 4. What happened to the purchasing power of the U.S. dollar if the base period for the cost-of-living index is 1980=100 and the index reached the following levels in the indicated years? a. 1985 116 b. 1990 127 c. 1995 134 d. 2000 151 e. 2005 170

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ANSWER: From Purchasing Power of the U.S. dollar equal to 1 divided Cost of Living Index where goods and services are sold in U.S. dollars multiplied by 100. a. The U.S. dollar's relative purchasing power has fallen to 1/116  100 = 0.86. In other words, the purchasing power of the U.S. dollar in 1985 was just 86% of its purchasing power in 1980. b. The U.S. dollar's relative purchasing power has fallen to 1/127  100 = 0.79. c. The U.S. dollar's relative purchasing power has fallen to 1/134  100 = 0.75. d. The U.S. dollar's relative purchasing power has fallen to 1/151  100 = 0.66. e. The U.S. dollar's relative purchasing power has fallen to 1/170  100 = 0.59. 5. A household receives $6,000 in income for the month of September. Which of the following could have been true of the household’s financial assets and liabilities (debt) if its total expenditures for the month amounted to $7,000? a. b. c. d.

Its financial assets grew by $1,000 and its debt grew by $2,000. Its financial assets fell by $1,000 and its debt grew by $2,000. Its financial assets grew by $2,000 and its debt grew by $1,000. Its financial assets grew by $2,000 and its debt fell by $1,000.

ANSWER: The true answer is a. 6. Marvin purchases a $2,000 computer on line using his credit card. His wife, Jane, purchases an identical computer with a check. For Marvin and Jane’s combined household balance sheet: a. Total assets have increased by $4,000, but there has been no change in net worth. b. Total assets have increased by $4,000, while total liabilities rose by $2,000. c. Total financial assets fell by $2,000, while total liabilities rose by $2,000. d. Total financial assets fell by $2,000, while net worth remained unchanged. ANSWER: The true answer is c. EXCEL 7. Jack and Jill are small business persons who run a hot dog stand licensed to operate outside a business shopping district. They have been so successful that they believe a second hot dog stand in the area also would be profitable. The capital expense to set it up would be $10,000 and they are considering several options. Use a spreadsheet to evaluate these options by inserting (i) their receipts in column one; (ii) expenses in column two; (iii) change in financial assets in column three; and change in their debt in column (iv). State whether they would be a surplus-budget unit or a deficit budget unit under each option. a. Their sales for the month turn out to be $12,000 and their expenses are $9,500; they borrow $10,000 for the new stand. ANSWER: They would be a deficit budget: Receipts $12,000

Expenses Change in Financial Assets $19,500

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Change in Debt $7,500


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b. Their sales for the months turn out to be $15,000 and their expenses are $9,500; they sell $5,000 in stock and borrow the remaining funds needed to finance the new stand. ANSWER: They would be a surplus budget: Receipts $15,000

Expenses $19,500

Change in Financial Assets -$5,000

Change in Debt -$500

c. Their sales for the month turn out to be $8,000 and their expenses $9,500; they choose neither borrow any funds nor build the second stand. ANSWER: They would be a deficit budget: Receipts $8,000

Expenses Change in Financial Assets -$1,500

Change in Debt

d. Their sales for the month turn out to be $8,000 and their expenses $9,500; they use $5,000 in their bank account (with no other asset sales) to help finance the new stand. ANSWER: They would be a deficit budget: Receipts $8,000

Expenses $19,500

Change in Financial Assets -$5,000

Change in Debt $6,500

Web-Based Problems 1. The total volume of primary securities created by the banking system as a whole is referred to as bank credit. The total volume of secondary securities issued by the banking system is given by the banks’ total liabilities minus any interbank lending, referred to as either “borrowings from other banks” or “federal funds purchased.” a. Go to the website of the Federal Reserve System and find its H.8 statistical release: www.federalreserve.gov/releases/h8/Current/. Identify the total volume of primary and secondary securities for the banking system as a whole for the most recent quarter. Answer: For May 2007 (Monthly), the total volume of primary securities (Bank Credit) for the banking system is $8,542.4 billions. The banks’ total liabilities are $8,960.0 billions. The interbank lending is $354.2 billions. The total volume of secondary securities for the banking system for May 2007 is $8,605.8 billions ($8,960.0 – $354.2 = $8,605.8). b. Compute the difference between the total amount of credit created by the banking system in the form of primary securities and the banking system’s liabilities in the form of secondary securities. What does this difference represent? What is this difference expressed as a percentage of total assets in the banking system?

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Answer: The difference between the total amount of credit created by the banking system in the form of primary securities and the banking system’s liabilities in the form of secondary securities is $417.6 billions ($8,542.4 – $8,960.0 = -$417.6), which is used to sell the liabilities to the outside the banking system. The difference is equivalent to 4.19 percent of the total assets ($9,971.5 billions) in the banking system. c. See if you can find annual balance sheets for at least two of the longest U.S. banks – for example Bank of America (BAC) and Wells Fargo (WFC). Identify the total amount of primary securities (investment securities plus loans, claims and advances) and secondary securities (customer deposits plus short-term borrowings less federal funds purchased) for each bank. Perform similar calculations as in part (b) to determine what percentage of the total assets for each of these banks is the difference between primary and secondary securities on their books. Does this tell you anything about these very large banks relative to the banking industry as a whole? Answer: For Bank of America from http://investor.bankofamerica.com For December 31st, 2006, the total amount of primary securities (investment securities plus loans, claims and advances) is $890,320 millions ($697,474 + $192,846 = $890,320) and the total amount of secondary securities (customer deposits plus short-term borrowings less federal funds purchased) is $617,270 millions ($693,497 + $141,300 - $217,527 = $617,270). The difference between the amounts of primary and secondary securities is $273,050 millions ($890,320 – $617,270 = $273,050). The difference is equivalent to 18.7% of the bank’s total assets ($1,459,737 millions) For December 31st, 2005, the total amount of primary securities is $787,349 millions ($565,746 + $221,603 = $787,349) and the total amount of secondary securities is $510,284 millions ($634,670 + $116,269 - $240,655 = $510,284). The difference between the amounts of primary and secondary securities is $277,065 millions ($787,349– $510,284 = $277,065). The difference is equivalent to 21.4% of the bank’s total assets ($1,291,803 millions) For Wells Fargo & Co from https://www.wellsfargo.com. For December 31st, 2006, the total amount of primary securities is $315,352 millions and the total amount of secondary securities is $323,072 millions. The difference between the amounts of primary and secondary securities is shortage $7,720 millions ($315,352 – $323,072 = -$7,720). The difference is equivalent to 1.6% of the bank’s total assets ($481,996 millions) For December 31st, 2005, the total amount of primary securities is $306,966 millions and the total amount of secondary securities is $338,342 millions. The difference between the amounts of primary and secondary securities is shortage $31,376 millions ($306,966 – $338,342 = -$31,376). The difference is equivalent to 6.5% of the bank’s total assets ($481,471 millions) 2. Most major security dealers houses engage in both semidirect and indirect financing in their roles as financial intermediaries.

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a. Identify which of these two types of financing should show up on the intermediary's balance sheet and which should not. Explain. Answer: The semidirect financing should not show up on the financial intermediary's balance sheet and the indirect financing should, since the former merely facilitates a transaction between the ultimate borrower and the ultimate lender, whereas the latter borrows from the ultimate lender, thereby creating a liability, and lending to the ultimate borrower, thereby creating an asset. b. How would you expect these two different types of financial transactions to show up on the intermediary's income statement? Answer: Semidirect finance requires paying fees and commissions to market makers--such expenses may show up on the borrower’s income statement as revenues. Indirect finance actually earns a spread from the different interest rates agreed with the intermediary’s ultimate borrowers (higher interest rate) and lenders (lower interest rate). Such an interest income earned would show up as revenues and the payments to the ultimate lender would show up as interest expense. c. Consult the worldwide web for the annual balance sheet and income statement of a major dealer house such as Lehman Brothers (www.lehman.com) or Goldman Sachs (www.gs.com). Identify the semidirect and indirect finance activities of these or other dealer houses. Answer: For Lehman Brothers, the semidirect is shown in the form of commission and fee and the indirect is shown in the form of Interest and dividends. In 2006, Lehman Brothers receives the revenue in the form of commission equal to $2,050 millions and in the form of interest and dividends equal to $30,284 millions. For Goldman Sachs, the semidirect is shown in the form of asset management and securities services and the indirect is shown in the trading and principle investment. In 2006, Goldman Sachs receives the revenue in the form of asset management and securities services equal to $6,474 millions and in the form of the trading and principle investment equal to $25,562 millions.

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Solution manual money and capital markets 10th edition rose  

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