21 - Chapter Twenty One Product Diversification Chapter...

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Chapter Twenty One Product Diversification Chapter Outline Introduction Risks of Product Segmentation Segmentation in the U.S. Financial Services Industry Commercial and Investment Banking Activities Banking and Insurance Commercial Banking and Commerce Nonbank Financial Service Firms and Commerce Activity Restrictions in the United States versus Other Countries Issues Involved in the Diversification of Product Offerings Safety and Soundness Concerns Economies of Scale and Scope Conflicts of Interest Deposit Insurance Regulatory Oversight Competition Summary 255
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Solutions for End-of-Chapter Questions and Problems: Chapter Twenty One 1. How does product segmentation reduce the risks of FIs? How does it increase the risks of FIs? Product segmentation reduces the risks of FIs by forcing them to specialize. Specialization generates expertise and access to information, which should enable FIs to more accurately price excessively risky situations. Product segmentation also increases the risk of the FI because the benefits of diversification are reduced. Thus specialization leaves the FI more exposed to downturns in the specific market to which it is confined. 2. In what ways have other FIs taken advantage of the restrictions on product diversification imposed on commercial banks? Money market mutual funds that offer checking account-like deposits services have removed low cost deposits from bank balance sheets. Insurance companies have successfully offered annuities as savings products to compete with bank CDs. The commercial paper market has provided very effective competition for commercial lending activities of banks, and unregulated finance companies continue to make market share gains in the business credit market. 3. How does product segmentation reduce the profitability of FIs? How does product segmentation increase the profitability of FIs? Product segmentation reduces the profitability of FIs by preventing them from exploiting economies of scope across products. Moreover, tie-in sales across markets are restricted. Customers are lost to FIs that could more completely supply all of their customers' financial services needs. Since customer relationships produce information and are profitable, this reduces the profitability of segmented FIs. Product segmentation also increases the profitability of FIs by providing incentives for the FI to develop technology and other innovations to improve production efficiency. 4. What general prohibition regarding the activities of commercial banking and investment banking did the Glass-Steagall Act impose? What investment banking activities have been permitted for U.S. commercial banks? Sections 16 and 21 of the Glass-Steagall Act specifically prohibited banks from engaging in the underwriting, issuing, and distributing of stocks, bonds, and other securities, while specifically prohibiting investment banks from taking deposits and making commercial loans.
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