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Chapter Ten
The Investment Function in Financial Services Management
Key Topics
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
McGraw-Hill/Irwin Bank Management and Financial Services, 7/e 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Maturity Beyond One Year Higher Expected Rate of Return Capital Gains Potential
McGraw-Hill/Irwin Bank Management and Financial Services, 7/e 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
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Quick Quiz
Why do banks and other institutions choose to devote a significant portion of their assets to investment securities? What are the principal money market and capital market instruments available to institutions today? What types of investment securities do banks seem to prefer the most? By size of institutions? Explain. What risks do securitized assets present to institutions investing in them?
McGraw-Hill/Irwin Bank Management and Financial Services, 7/e 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
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Liquidity Risk Call Risk Prepayment Risk Inflation Risk Pledging Requirements
2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
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HP
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Tax Exposure
The Tax Status of State and Local Government Bonds Bank Qualified Bonds
Tax Swapping Tool The Portfolio Shifting Tool
McGraw-Hill/Irwin Bank Management and Financial Services, 7/e 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
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Default Risk
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Business Risk
Risk that the Economy of the Market Area they Serve May Turn Down Security Portfolio Can Offset This Risk
Securities Can be Purchased From Outside Market Area Served
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Liquidity Risk
Breadth and Depth of Secondary Market
Number of Traders on an Given Day Volume of Trades on Any Given Day
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Call Risk
Corporations and Some Governments Reserve the Right to Retire the Securities in Advance of Their Maturity Generally Called When Interest Rates a Have Fallen Investor Must Find New Security Often with a Lower Return
McGraw-Hill/Irwin Bank Management and Financial Services, 7/e 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
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Prepayment Risk
Specific to Asset-Backed Securities
Most Consumer Mortgages and Loans Can Be Paid Off Early Caused by Loan Refinancing Which Accelerate When Interest Rates Fall Caused by Asset Turnover When Borrowers Move or are Not Able to Meet Loan Payments and Asset is Sold McGraw-Hill/Irwin 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
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Inflation Risk
Purchasing Power from a Security or Loan May be Eroded by Rising Prices Recently Developed Inflation Risk Hedge Treasury Inflation Protected Securities Both Coupon Payments and Principal Adjusted Annually for Inflation Based on Consumer Price Index
McGraw-Hill/Irwin Bank Management and Financial Services, 7/e 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
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Pledging Requirements
Depository Institutions Cannot Accept Federal, State and Local Government Deposits Unless Acceptable Collateral is Pledged
Generally Treasury Securities, Government Agency Securities and Selected Municipal Securities Can Be Used as Collateral
McGraw-Hill/Irwin Bank Management and Financial Services, 7/e 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
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Quick Quiz
If a government bond is expected to mature in two years and has a current price of $950, what is the bonds YTM if it has a par value of $1000 and a promised coupon rate of 10 percent? Suppose this bond is sold one year after purchase for a price of $970. What would this investors holding period return be? How can the yield curve and duration help an investment officer choose which securities to acquire or sell? McGraw-Hill/Irwin
Bank Management and Financial Services, 7/e