Chapter 2

Financial Institutions,
Financial Intermediaries and
Asset Management Firms

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 Services of Financial Institutions
Transforming Financial Assets
Exchanging Financial Assets on Behalf of
Customers
Exchanging Financial Assets for Own Account
Assisting in the Creation of Financial Assets
Providing Investment Advice
Managing Portfolios

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 Role of Financial Intermediaries
Transfer of funds from savers to investors
Types of Investments
Direct Investment
For example, purchasing a portfolio of stocks and
bonds
Indirect Investment
For example, purchasing an equity claim issued by
an investment company

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 Role of Financial Intermediaries
Providing Maturity Intermediation
Reducing Risk Through Diversification
Reducing Costs of Contracting and
Information Processing
Providing a Payments Mechanism

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 Role of Financial Intermediaries
Providing Maturity Intermediation
Reducing Risk via Diversification
Reducing Costs of Contracting and
Information Processing
Providing a Payments Mechanism

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 Asset/Liability Management
Spread and Non-Spread Businesses
Nature of Liabilities
Amount of cash outlay
Timing of cash outlay
Liquidity Concerns
Regulations and Taxation

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Nature of Liabilities of Financial
Institutions
Amount of Cash Timing of Cash
Liability Type Outlay Outlay

Type I Known Known

7
Type II Known Uncertain

Type III Uncertain Known

Type IV Uncertain Uncertain

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 Concerns of Regulators
Credit Risk
Settlement Risk
Counterparty Risk
Liquidity Risk
Market Liquidity Risk
Funding Liquidity Risk
Market Risk
Operational Risk

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 Asset Management Firms

Ranked by assets under management

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 Fees and Compensation

Fee structure
Fee based on assets under management
Performance-based fee

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 Types of Funds Managed
Regulated investment companies
Insurance company funds
Separately managed accounts
Pension funds
Hedge funds

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 Hedge Funds
No single definition of hedge fund
George Soros
President’s Working Group on Financial
Markets
U.K. Financial Services Autority

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 Hedge Fund Characteristics
“Hedge” is misleading
Wide range of trading strategies
Leverage, short selling, arbitrage, risk control
Operate in all financial markets
Focus on absolute returns
Lastly, funds cater to sophisticated
investors

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 Types of Hedge Fund
Market directional hedge fund
Corporate restructuring hedge fund
Convergence trading hedge fund
Opportunistic hedge fund

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 Concerns with Hedge Fund
Hedge funds provide market benefits
Liquidity
Market pricing efficiency
However, there are concerns
System risk
Long-Term Capital Management
Bear Stearns
Market meltdown of 2008

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