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Unformatted text preview: CHAPTER 10 THE INVESTMENT FUNCTION IN BANKING AND FINANCIAL SERVICES MANAGEMENT Goal of This Chapter : The purpose of this chapter is to discover the types of securities that financial institutions acquire for their investment portfolio and to explore the factors that a manager should consider in determining what securities a financial institution should buy or sell. Key Topics in This Chapter Nature and Functions of Investments Investment Securities Available: Advantages and Disadvantages Measuring Expected Returns Taxes, Credit, and Interest Rate Risks Liquidity, Prepayment, and Other Risks Investment Maturity Strategies Maturity Management Tools Chapter Outline I. Introduction: The Roles Performed by Investment Securities in Bank Portfolios II. Investment Instruments Available to Banks and Other Financial Firms III. Popular Money-Market Instruments A. Treasury Bills B. Short-Term Treasury Notes and Bonds C. Federal Agency Securities D. Certificates of Deposit E. International Eurocurrency Deposits F. Bankers' Acceptances G. Commercial Paper H. Short-Term Municipal Obligations IV. Popular Capital Market Instruments A. Treasury Notes and Bonds B. Municipal Notes and Bonds C. Corporate Notes and Bonds III. Other Investment Instruments Developed More Recently A. Structured Notes B. Securitized Assets C. Stripped Securities IV. Investment Securities Actually Held by Banks 128 V. Factors Affecting the Choice of Investment Securities A. Expected Rate of Return B. Tax Exposure 1. The Tax Status of State and Local Government Bonds 2. Bank Qualified Bonds 3. Tax Swapping Tool 4. The Portfolio Shifting Tool C. Interest-Rate Risk D. Credit or Default Risk E. Business Risk F. Liquidity Risk G. Call Risk H. Prepayment Risk I. Inflation Risk J. Pledging Requirements VI. Investment Maturity Strategies A. The Ladder or Spaced-Maturity Policy B. The Front-End Load Maturity Policy C. The Back-End Load Maturity Policy D. The Barbell Strategy E. The Rate Expectations Approach VII. Maturity Management Tools A. The Yield Curve B. Duration VIII. Summary of the Chapter Concept Checks 10-1. Why do banks and institutions choose to devote a significant portion of their assets to investment securities? Investments perform many different roles that act as a necessary complement to the advantages loans provide. Investments generally have less credit risk than loans, allow the bank or thrift institution to diversify into different localities than most of its loans permit, provide additional liquid reserves in case more cash is needed, provide collateral as called for by law and regulation to back government deposits, help to stabilize bank income over the business cycle, and aid banks in reducing their exposure to taxes....
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