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Markets Financial and Institutions Professor Doug Smith Thrifts and Consumer Finance Operations Concept Questions Assignment 11-2 Jamie Hinson December 3, 2007 Question number one on page 640 from the Questions and Applications section is: Explain in general terms how savings institutions differ from commercial banks with respect to their sources of funds and uses of funds. Discuss each source of funds for savings institutions. Identify and discuss the main uses of funds for savings institutions, asked by Jeff Madura, author of Financial Markets and Institutions. Savings institutions rely on most of their funds generating from savings such as passbook savings and certificate deposits and money market deposit accounts. Commercial banks focus on business and residential commercial loans. There are three main sources of funds that savings institutions use when needed. First, they can borrow from other depository institutions that have access funds in the federal fund market. The interest rate on funds borrowed in this market is referred to as the federal funds rate. Second, they can borrow at the Federal Reserves discount window. The interest rate on funds borrowed from the Fed is referred to as the discount rate. Third, they can borrow through a repurchase agreement (repo). With a repo, an institution sells government securities, with a commitment to repurchase those securities shortly thereafter, according to Madura. Question number five asks to discuss the entrance of savings institutions into consumer and commercial lending. What are the potential risks and rewards of this strategy? Discuss the conflict between diversification and specialization of savings institutions. Many lending guidelines for savings institutions have loosened and were granted more flexibility to their consumer and commercial loans. The increase emphasis on corporate and consumer loans can increase an SIs overall degree of credit risk. The loss rate on mortgage loans has been significantly lower than the loss rate on credit card loans. Despite their moves into corporate and consumer lending, SIs participation in these fields is still limited by regulators. Thus, mortgages and mortgage-backed securities continue to be their primary assets, according to Madura. Question fifteen asks: Who are the owners of credit unions? Explain the tax status of credit unions and the reason for that status. What is the typical size and the reason for that status. What is the typical size range of credit unions? Give reasons for that range. Credit unions are owned by the depositors, which are called shares. credit Because unions are nonprofit organizations, they are not taxed, which makes it easy for them to offer attractive rates to their members. Some characteristics of CUs can be unfavorable. Their volunteer labor may not have the incentive to manage operations efficiently. In addition, the common bond requirement for membership restricts a given CU from growing beyond the potential size of that particular affiliation. If that institution lays off a number of workers, many members may simultaneously experience financial problems and withdraw their share deposits or default on their loans, according to Madura. Question number one on page 652 asks: Is the cost of funds obtained by finance companies very sensitive to market interest rate movements? Explain. Finance companies are not susceptible to the rising of interest rates. Their assets are not as rate sensitive as their liabilities. They can shorten their average asset life to make greater use of adjustable rates of they wish to reduce their interest rate risk, according to Madura. Question number four asks to describe the major uses of funds by finance companies. A finance companys major uses of funds consist of: Consumer loans, business loans and leasing, ad real estate loans. In consumer loans, Finance companies increase their customer base in this way and are accessible for additional financing for those customers who prove to be creditworthy. In business loans, some finance companies provide loans to support leveraged buyouts. These loans are generally riskier than other business loans but offer a higher expected return. By leasing, the company purchases machinery or equipment and then leases it to businesses that prefer to avoid the additional debt on their balance sheet that purchases would require. In real estate loans, the offering of second mortgages has become increasingly popular over time. These mortgages are typically secured and historically have a relatively low default rate, according to Madura. Question nine asks to explain how the interest rate risk of finance companies differs from that of savings institutions. Both liability and asset maturities of finance companies are short or intermediate term. Therefore, they are not as susceptible to increasing interest rates as are savings institutions. Finance companies can still be adversely affected, however, because their assets are typically not as rate sensitive as their liabilities. They can shorten their average asset life or make greater use of adjustable rates if they wish to reduce their interest rate risk, according to Madura. ... View Full Document

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