FINANCE 3303: SECURITIES MARKETS
FINANCE 4313: FINANCIAL INSTITUTIONS
MANAGEMENT
Lecture Notes
Raymond H. Diggle, Jr., CFA
© 1999 University of Central Florida
This workbook is a compilation of class handouts.
It has been prepared to help you understand concepts
and do well on examinations. Please bring this workbook
to each class with your financial calculator.
I AM HERE TO HELP. HOME TEL: (904) 615-0700
PLEASE CALL BEFORE 9 PM
OFFICES:
BLDG 36 200B DAYTONA
TEL: 904-254-4412 x 4030
ROOM 345
BREVARD
TEL: 407-632-1111 X 65576
MY WEBSITE: http://pegasus.cc.ucf.edu/~rdiggle/diggle.html
OFFICE HOURS ARE POSTED ON OFFICE DOOR AND IN SYLLABUS
2
THE UNIVERSITY OF CENTRAL FLORIDA
SCHOOL OF BUSINESS ADMIN
SYLLABUS SYNOPSIS
FIN 3303 SECURITIES MARKETS
INSTRUCTOR
R. H. DIGGLE, JR, CFA
OFFICE HOURS
See syllabus
OFFICE NUMBER
BLDG 36 ROOM 200B
TEL: 904-254-4412
HOME (NOT AFTER 9 PM) 904 - 615- 0700
http://pegasus.cc.ucf.edu/~rdiggle/diggle.html
COURSE DESCRIPTION: (Prerequisites: FIN 3403 May not be taken concurrently)
The course deals with nonbank and bank institutions as participants in money and capital markets.
The function of financial markets, which is to provide a link between savings and investment, is
analyzed within the context of the suppliers and users of loanable funds. The growth and changing
roles of nonbank financial intermediaries and their financial instruments are related to money and
capital markets through specific instruments:
COURSE OBJECTIVES:
To explore the changing role of financial markets and institutions through text readings,
presentations and other means including field trips if possible. Focus will be on:
Role of specific institutions in the U.S. economy
Understanding money and capital markets
Legal history and regulatory trends affecting institutions and markets in the U.S. with a
primary focus on commercial banking and the Fed.
Team analysis of a commercial bank
TEXTBOOKS:
REQUIRED TEXTS: Financial Institutions Markets and Money, Kidwell, Peterson &
Blackwell, Dryden Press, 1997.
Lecture Notes, R. H. Diggle, Jr.
HIGHLY RECOMMENDED
A financial calculator such as the Texas Instruments Business Analyst II plus (TI BA II+ )
The Wall Street Journal (student subscription sign up will be the second week of class. Students may share
subscriptions. The WSJ will be used in several group and individual assignments)
GRADING:
Midterm plus final exam ##
60% ##
Team projects 1 and 2
Team analysis project 3
Homework and class partic.
15%
15%
10%
## Exams may be take home
2
A
B
C
D
F
91 - 100%
82 - 91
73 - 82
64 - 73
< 64
3
THE UNIVERSITY OF CENTRAL FLORIDA
SCHOOL OF BUSINESS ADMIN
SYLLABUS SYNOPSIS
FIN 4313 FINANCIAL INSTITUTIONS MANAGEMENT
INSTRUCTOR
R. H. DIGGLE, JR, CFA
OFFICE HOURS
See syllabus
TEL: 904-254-4412
HOME (NOT AFTER 9 PM) 904 - 615- 0700
http://pegasus.cc.ucf.edu/~rdiggle/diggle.html
OFFICE NUMBER
BLDG 36 ROOM 200B
DAYTONA
COURSE DESCRIPTION: (Prerequisites: FIN 3303, AND 3403 May not be taken concurrently)
The course deals management policies of financial institutions including:
Portfolio strategy and structure
Asset-Liability management
GAP
Impact of interest rates on asset duration and portfolio
The economics and impact of competition, mergers and acquisitions, and regulatory agencies is also
considered.
COURSE OBJECTIVES:
To explore the changing role of financial institutions through text readings, presentations and other
means including field trips if possible. Focus will be on:
Financial modeling
Portfolio management risk reduction techniques including options and futures.
Balance sheet and portfolio characteristics of institutions
Current trends impacting global financial institutions and markets
TEXTBOOKS:
REQUIRED TEXTS: Financial Institutions Management, A. Saunders, 2nd. Ed. Irwin, 1997
Lecture Notes, R. H. Diggle, Jr.
The TIBA2+ Financial calculator
HIGHLY RECOMMENDED
The Wall Street Journal (student subscription sign up will be the second week of class. Students may share
subscriptions. The WSJ will be used in several group and individual assignments)
GRADING:
Midterm plus final exam ##
50% ##
Term paper
EXCEL BASED HOMEWORK
Class participation
15%
25%
10%
## Midterm may be take home
INTRODUCTION
3
A
B
C
D
F
91 - 100%
82 - 91
73 - 82
64 - 73
< 64
4
This workbook is intended to supplement your text and help you study for examinations.
FIN 3303: This book contains specific group assignments on several topics relating to financial
institutions, financial markets, and a company analysis project. These group assignments are
designed to give you experience in working with others which typical of the way businesses function
today.
FIN 4313: There are no team assignments in this advanced course.
Please bring these lecture notes with you to class.
TABLE OF CONTENTS
TOPIC
PAGES
FIN 3303 CLASS NOTES AND PROJECTS
FIN 4313 CLASS NOTES AND PROJECTS
A. FIN 3303
Bank ratio analysis project
The Role of Money
Money and financial institutions
Financial Markets and Institutions
TEAM PROJECT 1: NOTES
Financial Instruments
TEAM PROJECT 2: NOTES
Financial markets
Financial instruments
Interest Rates
Role of the Fed, Monetary Policy
B. FIN 3303 INTRO -- FIN 4313 ADVANCED
Understanding bank financial statements
Chronology of U.S. Key Banking Legislation
Monetary Creation within the Banking System
C. FIN 4313
Bonds
Portfolio strategy and composition
M&A (mergers and acquisition analysis of a bank)
Securitization
Introduction to Options
APPENDIX
Reference source materials
Excel spreadsheet financial functiona
TVM Review
Using a Financial Calculator Review
Bond and Stock Valuation Concepts
Macroeconomics: The twin deficits
Current events
Career Opportunities
Resume Preparation and Interviewing
Business writing
The AIMR and CFA Designation
The Jennifer L. Diggle Scholarship
5
6
7-9
10-11
12-14
14-15
14
13-14
15
15
16-17
18-19
19-20
21-23
24
25
26
28-30
32-35
36
37
38-39
39
40
41-43
44-45
46-48
49
50-51
52-53
54-56
57
58
59
60
Please refer to the syllabus for exact dates of assignments and team reports.
Readings for FIN 4313 may include parts of FIN 3303 material above
4
5
CLASS NOTES: FIN 3303
A. GROUP PROJECTS: TEAM ORGANIZATION
Each student will sign up as part of a team early in the term. There will be 3-5 teams depending on class
size. Teams will prepare 3 class presentations as outlined below. All team presentations are FAIR GAME
FOR EXAMINATIONS. All 3 projects constitute 30% of your grade. Peer evaluations will be made.
1. TEAM CLASS PRESENTATION 1: FINANCIAL INSTITUTIONS 7.5% of grade
(SEE ASSIGNMENT SHEET)
TEAM PROJECT 1
PRESENTATION 1:
TEAM 1
COMMERCIAL BANKING
PRESENTATION 2:
TEAM 2
THRIFTS
PRESENTATION 3:
TEAM 3
INSURANCE / PENSION ADMIN.
PRESENTATION 4:
TEAM 4
INVESTMENT BANKING / BROKERAGE
PRESENTATION 5:
TEAM 5 (if needed)
MUTUAL FUNDS
This report should be 15 minutes in length. Use powerpoint for presentation. Give a one page handout to class.
Provide instructor with copies of all handouts or slides. Use current data and statistical information.
1. Begin by describing the industry in the U.S., its size and growth. Get currrent data from internet.
2. What economic function do they serve? Who are their customers?
3. Next, describe the institution in terms of assets and liabilities or sources and uses of funds.
4. Portfolio: What do they invest in and why?
Next, describe this financial institution in the following contexts:
 Regulatory environment
(who are regulators)
 Legal and political environment
(describe key legislation in the U.S. affecting this institution)
 Competition
( Use the internet, or other library sources)
 Career opportunities
2. TEAM CLASS PRESENTATION 2: FINANCIAL MARKETS
PRESENTATION 1:
TEAM 1
FIXED INCOME MARKETS
PRESENTATION 2:
TEAM 2
EQUITY MARKETS
PRESENTATION 3:
TEAM 3
MORTGAGE MARKETS
PRESENTATION 4:
TEAM 4 (if needed)
FUTURES AND OPTIONS
PRESENTATION 5:
TEAM 5 (if needed)
INERNATIONAL EXCHANGE
Using text material in chapter cited and other sources prepare a 10 minute presentation as follows:
1. What are the economic functions of this market.
2. Discuss key elements or instruments traded in the market.
3. Explain how the trading actually functions.
4. How do investors access these markets today?
Presentation should be in Powerpoint with a 1 page class handout.
7.5% of course grade
CH 9
CH 10
CH 11
CH 12
CH 13
3. ANALYSIS OF A FINANCIAL INSTITUTION. TEAM PROJECT 3 15% of grade
This project requires the financial analysis of a COMMERCIAL BANK. See notes on next 3 pages.
Your immediate job is to pick a bank during the SECOND WEEK of class and order hard copies of the last annual report,
10K, and proxy. Your bank must NOT have been analyzed in this class in the past 2 years.
GRADING
Each team will receive a TEAM GRADE on each project. Individual grades will be based on the
instructor evaluation of your active participation in team meetings and presentations. Teams may
organize in any way they see fit. However, since your grade is dependent on the work of all team
members, peer evaluation forms will be used to monitor individual participation. Each team will
select a team secretary who is charged with keeping attendance.
5
6
CLASS NOTES: FIN 4313
FIN 4313 requires proficiency with a financial calculator. We will use the TIBA2+
This course will not use teams. All work will be done individually since this is a small class.
EXCEL HOMEWORK ASSIGNMENTS
25% of course grade
1. Each student will receive a disk containing these lecture notes and an MS Excel file entitled FIN
4313 ASSIGNMENTS. There are 10 assignments on this disk. Please refer to the syllabus for
the due date of each assignment. Late papers will not be accepted. At the end of the term, each
student will turn in the completed MS.XLS computer disk.
2. Please review these assignments. Assignment 7 is an individual bank analysis that is similar to
that done in FIN 3303. Note that you are to do the work directly on the Excel spreadsheet and
print the document BEFORE class.
3. NOTE that class participation is important in a seminar course like this. It is VITAL that all
homework be completed before class. Students who are unprepared will be penalized.
TERM PAPER
15% of course grade
This is not a typical term paper. In this project, you will conceive, design and test a simple model
using MS Excel. The model will be designed to solve some quantitative problem facing a manager of
a bank or other financial institution.
Your paper will:
1. Define the problem and explore relevant literature (be sure and include a bibliography)
2. Explain the model inputs, formulas and outputs.
3. Explain how the model would be used.
4. Provide any additional tables, graphs or data in an appendix.
The Excel model will:
1. Be similar to other Excel models used in the homework assignments of this course.
2. Permit data to be changed easily and results to be read easily.
EXAMPLES:
1. A stock trading model to assist in assessing momentum, relative strength, valuation etc.
2. A stock selection model using ratios, valuation techniques etc and assigning a point score for each
variable.
3. A interest rate forecasting model or simple econometric model looking at macro trends.
Please see Assignment 10 in your excel spreadsheet for style notes.
See syllabus for due date. Late papers will not be accepted. Hand in MS.XLS disk with paper.
EXAMS
This course will have 2 exams. One of these may be take home. Exams will focus on quantitative
problems covered in homework assignments.
GRADING
This is a seminar course. Attendance and class participation is an important part of your grade.
Students who miss more than 3 classes in a once/week class should NOT EXPECT TO PASS THE
COURSE. It is also critical in a small class that you be on time. See syllabus for grade scale.
6
7
BANK RATIO ANALYSIS REPORT AND PRESENTATION: FIN 3303 and FIN 4313
The objective of this project is to give you exposure to real world financial statements for a financial institution. Each
team will receive a disk containing this Excel spreadsheet early in the term or it will be placed on the server in the School
of Business computer lab. Each institution will have a slightly different spreadsheet. This is for a commercial bank and
shows data input and sample output. INSTRUCTOR WILL WORK CLOSELY WITH EACH TEAM .
FIN 3303 ALL TEAMS DO A BANK
FIN 4313 INDIVIDUAL EFFORT. MORE ADVANCED MODEL
It is important to get started on this project early.
SAMPLE INPUT SHEET
FIN 3303 FIN 4313
BANK ANALYSIS
7/31/99
TEAM # :
ENTER DATA IN YELLOW CELLS
ENTER DATA FROM LATEST ANNUAL OR 10K
USE 5 YEAR HISTORICAL DATA
List names of team members below LEFT JUSTIFY
JOHN DOE
HILLIARY CLINTON
ELEANOR ROOSEVELT
J. P. MORGAN
SAMPLE –EXAMPLE
1
INSTRUCTIONS: This is a MS Excel spreadsheet.
Enter data only on page 1 in cells indicated. Check
your input. See instructor if you have questions.
ENTER: LTM E.P.S.
$
3.00
CUR. D.P.S.
$
1.00
LTM = last 12 mos through most recent qtr.
BANK:
AMALGAMATED NATIONALCOMMERCIAL BANK
TICKER: ANC
$
RECENT STOCK PRICE:
A. INCOME STATEMENT
FISCAL YEAR END
MONTH
YEAR
36.00
12
1995
ENTER DATA IN $MILLIONS (Except per share data)
NET INTEREST
OTHER
NET INTEREST
PRETAX
NET
SHARES
NET INTEREST
FED IN
INCOME
INCOME
EXPENSE
INCOME
INCOME
OUT
MARGIN
TAX PA
1991
1992
1993
1994
1995
1,000
$
500
$
700
$
800
$
512
266.00
1,100
$
600
$
800
$
900
$
576
266.00
1,200
$
700
$
900
$
1,000
$
640
270.00
1,350
$
800
$
1,000
$
1,150
$
736
275.00
1,500
$
900
$
1,100
$
1,300
$
832
277.33
63%
4%
50%
5 YR. CHG.
80%
57%
63%
2.50%
2.60%
2.70%
2.90%
3.10%
$
$
$
$
$
B. BALANCE SHEET
1991
1992
1993
1994
1995
5 YR. CHG.
FIN 3303
TOTAL
S.H.
LONG TERM
TOTAL
TOTAL
ASSETS
EQUITY
DEBT
LOANS
DEPOSITS
$
TOTAL
LOAN
INVESTMENTS CHARGEOFFS
17,800
$
1,300
$
100
$
10,000
$
15,000
$
5,000
$100
$
19,580
$
1,400
$
120
$
11,000
$
16,000
$
5,000
$125
$
21,538
$
1,500
$
120
$
12,000
$
17,000
$
5,000
$130
$
23,692
$
1,500
$
130
$
13,000
$
17,000
$
4,000
$125
$
26,061
$
2,000
$
130
$
14,000
$
17,500
$
3,500
$200
-30%
83%
46%
FIN 4313
TEAM COMPANY ANALYSIS
54%
30%
40%
DO NOT ENTER ANY DATA ON THIS PAGE.
TEAM
1
7
17%
COMMERCIAL BANK RATIO ANALYSIS
AMALGAMATED
PAGE 2
8
NATIONALCOMMERCIAL BANK
DATE:
7/31/97
COMMERCIAL BANK
RATIO ANALYSIS
-------------------LIQUIDITY--------------------LOAN/
1991
1992
1993
1994
1995
5 YR. CHG.
INVESTMENTS/
33.33%
$
0.7
31.25%
35.29%
1.14%
2%
43%
3%
$
0.7
29.41%
36.84%
1.08%
2%
44%
3%
$
0.8
23.53%
37.21%
0.96%
2%
49%
3%
$
0.8
20.00%
37.50%
1.43%
2%
48%
3%
20%
-40%
13%
43%
29%
DEPOSIT
RATIO
$
0.7
LEVERAGE
1991
1992
1993
1994
1995
5 YR. CHG.
AVERAGE
-----------PROFITABILITY------------------
OTHER
INCOME
AS % OF
TOTAL
33.33%
DEPOSITS
CHARGOFFS
AS % OF
LOANS
1.00%
NET
RETURN
RETURN
MARGIN
ON EQUITY
ON ASSETS
2%
3%
#DIV/0!
11%
-----------------------------VALUATION-----------------------------
L.T. DEBT/
HIGH PRICE/
LOW PRICE/
AVG. DIVD
DIVIDEND
EQUITY
EARNINGS
EARNINGS
YIELD
PAYOUT
8%
9.4
6.2
4.0%
31.2%
9%
8.8
6.9
4.1%
32.3%
8%
9.7
8.0
3.8%
33.8%
9%
10.5
8.2
3.6%
33.6%
7%
11.0
8.3
3.4%
33.3%
-16%
18%
34%
-14%
7%
8%
9.9
7.5
4%
33%
CURRENT MARKET VALUATION
LAST 12 MOS
PRICE
E.P.S.
$ 36.00
$
3.00
CURRENT
P/E
12.0
The Fin 4313 is a more advanced model but is similar to this.
8
F.I. TA
CURRENT
D.P.S.
$
1.00
RATE
9
STEPS IN PREPARING YOUR BANK PRESENTATION: FIN 3303 & 4313
1.
2.
3.
FIN 3303 WORK AS A TEAM.
FIN 4313 INDIVIDUAL WORK.
DO NOT PROCRASTINATE. GET STARTED EARLY IN TERM111
Check with instructor on your financial institution. Write for or visit the company and obtain:
 Last annual report and 10K YOU MUST HAVE A PUBLISHED ANNUAL REPORT / 10K
You can use the internet to get started but MUST provide instructor with a published report.
 Last 10Q (quarterly report) and proxy statement (the document sent to shareholders annually)
 Recent press releases. Use library databases to check recent news on your bank. Bear in mind that
many local financial institutions have been sold in recent years. .
 Current price, last 12 month earnings per share, and current dividend per share from Yahoo on my
web site. Print 5 year chart and check for recent splits. SEE INSTRUCTOR with this data.
4. Enter data in the spreadsheet. Each institution will have slightly different inputs. Enter names of team members.
5. SEE INSTRUCTOR AS A TEAM. Bring annual report and he will assist you in finding missing data items.
6. Look at trends in growth of assets, portfolio etc.
7. Examine the ratios. These will be defined for you. What conclusions can you draw? For example, what is the
loan/deposit ratio? For many banks, deposits are not growing as fast as loans so this ratio is much higher than the
historical 80% level. What does it mean if the loan/deposit ratio exceeds 1.0?
8. SEE INSTRUCTOR for assistance in interpreting output. DO YOUR BEST TO INTERPRET IT FIRST.
9. Begin preparation of slides and handouts for class.
 Overhead slides should use Microsoft POWERPOINT. If you have never used powerpoint, this is a
good time to start. It is easy. Instruction will be provided.
 Data on competitors. Do a slide on other financial institutions in the same market. Use Value Line
or Moody’s or internet sources. How large is your institution in assets relative to its competitors?
How is it growing loans, deposits and E.P.S. (earnings per share)?
 Data on ratios. What do they mean?
 Background data including recent news.
 Comment on the stock price if this institution is publically traded. If it has been acquired, give
details of acquisition (date, who bought them, price paid in terms of P/E (price/ earnings per share)
and Price / Book value per share. Many banks have been acquired recently in the 3.4+ price/book
value range.
8
FIN 4313 ONLY—SEE ASSIGNMENT 8 FIN 4313 STUDENTS DO NOT NEED TO DO PPT SLIDES
In addition to the above, complete additional pages on your spreadsheet dealing with:
A. Loan Mix
D. GAP
B. Investment analysis
E. Portfolio duration
C. Asset liability management
F. DDM valuation
9. Prepare handouts and slides (with cover sheet) for instructor.
10. Practice and time your presentation. It should take approximately 20 minutes. (30 MINUTES FOR 4313)
11. Prepare some questions to get class discussion going after your formal remarks.
This assignment will accomplish several goals:
You will learn something about real world financial statements and banking operations.
You will use MS Excel and Powerpoint which are skills that will help you in other classes and in your chosen career.
You will learn about ratio analysis of a bank and what to look for in choosing a “good” bank.
Teams should see instructor during office hours with questions regarding this project. Please see me as a team and
not individually. While some class time will be devoted to questions on this project, I will need to review your work
throughout the term and answer questions that are unique to your company. DO NOT PROCRASTINATE on this project.
I will assist each team in inputting data, evaluating key ratios and determining which banks represent good benchmarks or
comparatives.
9
10
FIN 3303: THE ROLE OF MONEY
MONEY AND BANKING REVIEW
An understanding of the role of money in any economy is necessary to understanding the role of financial
institutions and the governmental agencies that regulate them.
FUNCTIONS
Medium of exchange
PROPERTIES:
Portability
Store of value
Durability
Standard of value
Divisibility
Standard of payment / unit of accounting
Value
KINDS OF MONEY:
National Currency
Federal Reserve Notes
Coinage
Localized currency
Bank notes
Checks
demand deposits & NOW accounts
Other deposits
Time deposits (savings accounts and CDs)
Credit cards
Technically a loan—not money
Debit cards
Tied to a checking account
Barter
OFFICIAL DEFINITIONS OF MONEY STOCK IN THE UNITED STATES
M-1
LISTED IN ORDER OF LIQUIDITY
Currency + Demand deposits
M-2
M1 + Savings deposits and other time deposits + consumer money market mutual
funds + overnight repurchase agreements + overnight Eurodollar deposits.
M-3
M2 + large denomination time deposits and CDs + institutional money market
funds + term repos + term Eurodollars. (Term is longer than overnight)
MONETARY AGGREGATE
L
=
M3 + TREASURY BILLS + COMMERCIAL PAPER
+ U.S. EE SAVINGS BONDS + BANKERS
ACCEPTANCES.
Note that NONE of these definitions specifically
mention debit cards. A debit card is issued on a
checking account (demand deposit) and functions in the
same way as a check so it is part of M1.
VELOCITY OF MONEY
MV
M
V
P
Y
=
PY
= Money stock
= Velocity (turnover) of money
= Price level (inflation)
= Level of REAL output (GDP)
An increase in M can lead to an increase in P. This is what happened in post WWI Germany. Regulatory agencies such
as the U.S. Federal Reserve are concerned with keeping P or inflation low. One of the ways they can do this is by
managing growth in the monetary aggregates. Another is through interest rates. Increasing rates acts as a damper on
economic activity and GDP.
10
11
MONEY AND FINANCIAL INSTITUTIONS
The institutions we will study in this course are financial intermediaries. Their role is to direct money from SAVINGS
into various INVESTMENTS which leads to economic growth.
Keynesian economic theory says C + I + G =
Spending at all levels equals Gross Domestic product.
Keynes also says
S =I
GDP Consumption
+ Investment spending + Government
Savings = Investment
Financial intermediaries take in savings in various forms such as bank deposits or life insurance premiums and redirect it
into investments such as home mortgages or business loans. The growth of any economy is dependent on this process
which is depicted in graphic form at the top of pp. 56-57 of your text.
HOW ARE WE DIFFERENT?
The United States is different from most other industrial nations in the character of its financial institutions. Our
institutions are typically more specialized and fragmented. This fits with the American character of checks and balances.
Regulation is also often shared between the Federal Government and the States. Consider:
 In Japan and most of Asia, large banks not only own controlling interests in major industrial companies (i.e. banks
can own common stock in their portfolios) but they also make long term infrastructure development loans. In the
U.S. banks can only invest in Treasury and Muny bonds. Stocks are prohibited as a portfolio investment.
Commercial banks tend to focus on short term lending (except mortgages). Investment banking is our institution that
engages in long term equity financing. Investment banks and commercial banks were separated by the Glass Steagall
Act of 1933.
 The U.S. only a few years ago had 30,000 commercial banks. That number has been reduced sharply in recent years
to about 8000 currently. There are 5 banks in Canada and a handful of banks in most European countries and Japan.
The U.S. frontier mentality spawned a bank in every small town.
 Savings and Loans (also called Thrifts or Building and Loans) also are a uniquely American phenomenon although
there are institutions that appear similar in Europe. Part of the American dream has been home ownership. Jimmy
Stewart in the movie classic “It’s a Wonderful Life” characterizes our image of the paternalistic small town banker.
Thrifts were regulated to provide 1-4 family conventional residental mortgage loans with their primary funding
source being passbook savings accounts. The advent of consumer CDs and money market mutual funds changed this
source of funds and ultimately led to the demise of this institution.
 There is no National Corporation Act in the U.S. All U.S. corporations are chartered in a home state. The U.S.
insurance industry is not regulated by any Federal Agency at all. This huge industry is regulated by understaffed state
insurance commissions. In Europe the Federal Governments regulate all financial institutions.
THE ROLE OF THE U.S. AS A WORLD POWER
In the 18th and19th Century and until the end of WWII, the British Pound Sterling ruled supreme as the world standard for
international finance. In the 16th and 17th Centuries the Spanish “Pieces of Eight” were the international standard. George
Washington’s army at Valley Forge refused payment in the paper continental dollar and demanded their pay in silver
pieces of eight which was legal tender in most of the colonies.
After the Bretton Woods conference in New Hampshire in 1948, the U.S. emerged as the dominant world financial power
and the U.S. dollar became the international currency standard. This propelled U.S. Treasury bonds into the preeminent
position as setting interest rates not only for all instruments in the U.S., but globally as well. The recent Asian banking
crisis has caused a massive flow of funds into U.S. Treasuries (which are considered the safest investment in the world)
and has caused a further decline in U.S. interest rates. The U.S. Treasury yield curve forms the basis for much of the
world’s interest rates
FINANCIAL INSTITUTIONS: AN OVERVIEW (FIN 3303 TEXT CH 2)
11
12
DEPOSITORY INSTITUTIONS
1.
COMMERCIAL BANKS
(ALSO SEE CH. 14-16)
STATE CHARTERED
FEDERALLY CHARTERED
INSURANCE:
FUNCTION:
2.
FDIC (Federal Deposit Insurance Corp.)
“Department store of finance”
Business lending, consumer lending, credit card
and other short term loans (75% of loans)
Mortgages (1st & 2nd -- about 25% of loans).
Trust services, Intl. Letters of credit
THRIFTS (Savings and Loan Associations, and Mutual Savings Banks)
(SEE TEXT CH. 19)
STATE AND FEDERALLY CHARTERED
INSURANCE:
FUNCTION:
WAS FSLIC BEFORE THRIFT CRISIS OF THE 80s
NOW FDIC INSURED.
Originally established to make 1-4 family conventional
residential mortgage loans. Focus is now on broader
consumer lending but 75% of loan portfolio is mortgages.
Thrifts are disappearing. (see table on p. 537)
hey are being merged into commercial banks (domestic and
foreign).
3.
CREDIT UNIONS
STATE AND FEDERALLY CHARTERED
INSURANCE:
National Credit Union Administration
FUNCTION:
Originally organized as cooperative (mutual) savings organizations
where depositors (“members”) must have some common bond such
as being employees of a company or members of an organization.
Function was restricted tp accepting savings (time) deposits and
making loans to members. Regulations are being relaxed but are
being challenged by commercial banks. Some credit unions
accept “nonaffiliated” members.
B. NONDEPOSITORY INSTITUTIONS
1. INSURANCE COMPANIES (SEE TEXT CH. 19)
LIFE & HEALTH
P&C (property and casualty)
INSURANCE COMPANIES ARE ALL STATE CHARTERED AND ARE
REGULATED BY INSURANCE DEPTS. OF EACH STATE. THE “HOME
OFFICE” STATE ASSUMES PRIMARY RESPONSIBILITY.
MAY BE MUTUAL OR STOCK
FINANCIAL INSTITUTIONS contd.
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FUNCTION:
Life and P&C companies are completely different.
LIFE COMPANIES invest in LONG TERM assets like stocks, and
commercial real estate and long term bonds. About 75% of assets represent
policyholder’s “cash surrender value” of whole life policies.
TERMINOLOGY: TERM INSURANCE “Pure” life insurance protection.
Usually renewed annually. Premiums rise based on actuarial life expectancy.
WHOLE LIFE INSURANCE: “Permanent”
insurance. Premiums are level and in early years build up excess value
known as “cash surrender value.” This money may be borrowed against or
converted to an annuity later in life.
Whole life is the largest form of individual saving in the U.S.
P&C COMPANIES provide insurance for homeowners, autos, and personal
and business property of all kinds. Premiums tend to vary based on
regulations, and claims exposure. In Michigan, auto premiums are 2-3X the
rates in Indiana and Ohio because Michigan is a “NO-FAULT” state.
Similiarly, home insurance is cheap in Michigan compared to Florida
because we do not have hurricanes.
P&C companies invest in liquid, shorter-term investments because claims are
unpredictable.
2.
INVESTMENT COMPANIES -- OPEN AND CLOSED END (TEXT CH. 20)
REGULATED BY THE SEC.
OPEN END INVESTMENT COMPANIES ARE MUTUAL –I.E. THERE ARE NO
SHAREHOLDERS. THEIR CAPITALIZATION IS VARIABLE –I.E. THEY ARE ISSUING
AND REDEEMING SHARES AT “NET ASSET VALUE” EACH TRADING DAY.
Mutual funds are quoted in a separate section of the paper. There are over 5000 funds and the
number continues to grow.
TERMINOLOGY:
NAV “Net Asset Value” = Market value of all securities
in portfolio divided by shares outstanding on that day.
Closed end funds are listed on an exchange. The price of the fund may be at a
premium or discount to NAV. Closed end funds have fixed capitalizations (i.e. common
shares outstanding is fixed) whereas open end funds are constantly issuing and redeeming
shares at NAV.
3.
BROKERAGE AND INVESTMENT BANKING FIRMS
(TEXT CH. 20)
REGULATED BY THE SEC, NASD AND THE FEDERAL RESERVE
THE NASD = THE NATIONAL ASSN. OF SECURITIES DEALERS.
MAY BE PARTNERSHIPS OR CORPORATIONS
FUNCTIONS:
AGENCY VS. PRINCIPAL
“Make a market” in some local over-the-counter stocks.
FINANCIAL INSTITUTIONS contd.
BROKER / DEALER FUNCTIONS CONTD:
When the firm purchases and trades for its own account it is
acting as principal.
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RETAIL BROKERAGE AND MONEY MANAGEMENT
CORPORATE FINANCE (IPOs, Secondary offerings, and
M&A –mergers and acquisition consulting)
RESEARCH ON COMPANIES OR INDUSTRIES
FINANCIAL PLANNING
TEAM ASSIGNMENT 1: FINANCIAL INSTITUTIONS
Prepare a 15 minute team presentation for the class with handouts on ONE of the financial institutions listed above. Each
team will prepare a different institution. You may organize members of the team in any way you wish to complete the
report. As part of the report, you should visit a local financial institutions of the type assigned and learn what this
institution is doing in our community. Determine how they are audited and regulated. Find out career opportunities for
UCF graduates in this institution. Your team presentation should provide the following information in a Powerpoint
presentation and 1 page class handout:
1. Describe the economic functions of this institution in the U.S. economy today.
2. Describe the institution(s) you visited. Describe key products and services.
3. Provide industry data from the internet or other sources on asset size of this institution in the U.S. economy, number
of units (i.e. banks have declined from 30,000+ to about 9000 banks)
4. Who are the regulatory agencies that regulate this institution?
5. Discuss career opportunities with this kind of institution.
FINANCIAL MARKETS: FIN 3303 TEXT CH 3
TERMINOLOGY
PRIMARY MARKET
SECONDARY MARKET
The market for new issues of securities (stocks and bonds)
This market is regulated by the Securities and Exchange
Act. Sale of new issues must be done by a “prospectus”
which is a legal document sent to the SEC and to investors.
All mutual fund sales and purchases are a primary market
transaction.
All organized exchanges (including NYSE, American and
NASDAQ trade existing securities and are, therefore. In the
secondary market.)
MUTUAL
Owned by depositors or policy holders
Credit Unions, mutual savings banks and many
insurers like Nationwide are mutuals. Mutual funds are
correctly called “open end investment companies.”
EXCHANGE
Auction market such as the New York Stock Exchange (NYSE) –
also called the “Big Board.” Exchanges may also trade in
commodities such as the Chicago Mercantile Exchange (The
“Merc”). In an exchange there is a “specialist” who makes a
market in selected securities or commodities. He is, in effect, the
“auctioneer.”
OTC
The over-the-counter market functions without an exchange floor.
Market makers (firms acting as principal) are connected via a
global intranet. This is called NASDAQ in the U.S.
FINANCIAL MARKETS CONTD. FIN 3303
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TEAM PROJECT 2
TEAM ASSIGNMENTS—CONSULT SYLLABUS FOR DUE DATE
TEAM 1
FIXED INCOME MARKETS – TEXT CH. 9
Discuss instruments
Discuss markets such as the New York Bond exchange
Discuss how Treasury bonds are sold
TEAM 2
EQUITY MARETS – TEXT CH 10
Differentiate between auction markets like the NYSE and
intranet markets like Nasdaq
Discuss how a trade is executed and the role of the "specialist"
Comment on internet trading
TEAM 3
MORTGAGE MARKETS – TEXT CH. 11
Discuss instruments
Discuss "Securitization" and role of GNMA using a flow chart
Explan the standard mortgage agreement (see if you can get a sample)
TEAM 4
OPTIONS AND FUTURES – TEXT CH. 12
Using text material and these lecture notes define options, and futures
Contracts
Discuss the "Crash of 1987" described in the text
How are options used in hedging activities for financial institutions
In handout provide several examples of option trades
Show how to read options page in the WSJ
TEAM 5
FOREIGN EXCHANGE—TEXT CH 13 (depends on class size)
Discuss fixed and floating exchange rates and the "Bretton Woods" meeting
What causes one currency to appreciate vs. another?
Discuss the Euro
Discuss the roots of the "Asian Crisis" of 1997 and 1998
This assignment is similar to project 1.
Using text material in chapter cited and other sources prepare a 10 minute presentation as follows:
1. What are the economic functions of this market.
2. Discuss key elements or instruments traded in the market.
3. Explain how the trading actually functions.
4. How do investors access these markets today?
Presentation should be in Powerpoint with a 1 page class handout.
Please mention types of FINANCIAL INSTRUMENTS (see text and pp. 14-15 below) relating to each market. Define
the instrument and explain its economic function.
I will make specific comments designed to “fill in” concepts and theory after each presentation. NUMBER OF TEAMS
DEPENDS ON CLASS SIZE.
FINANCIAL INSTRUMENTS
INSTRUMENT
T-BILLS
MONEY MARKET
< 1 YEAR IN DURATION
Short term debt of the Federal Govt.
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FEDERAL FUNDS
COMMERCIAL PAPER
Issued in 90, 180 and 360 day maturities
Sold at a DISCOUNT
T-bills are “risk free” (FREE OF BUSINESS OR DEFAULT RISK)
and form the basis for
all other money market rates
Interbank overnight loans secured by deposits at the Fed.
Short term debt instrument of a large corporation or its
finance subsidiary such as FMCC sold through brokers.
Quality of paper is “Rated” by firms such as S&P, Moody’s.
Fitch, or Duff and Phelps.
BANKER ACCEPTANCES
Letter of credit (a bank’s promise to pay) that has been
stamped “guaranteed” by another bank. Like a post dated check.
Used widely in international finance.
NEGOTIABLE CDs
Debt instruments issued by banks paying a stated interest.
No penalty for early withdrawal – Can be resold in secondary
mkt (unlike consumer CDs) may or may not be FDIC insured
Issued in denominations of $100,000 minimum
MMM FUNDS
A portfolio of other MM instruments (i.e.: bills and commercial
paper, etc). Portfolio Net Asset Value (NAV) is kept at $1.00
so theoretically there is no principal fluctuation.
EURODOLLARS
U.S. dollar denominated deposits of U.S. commercial banks with
banks in foreign countries. These IOUs are actively traded in all
international exchanges based on current exchange rates.
CONSUMER CREDIT PAPER
Packaged groups of loans that are traded in major exchanges at a
discount based on risk level of “portfolio.”
INSTRUMENT
CAPITAL MARKET
TREASURY NOTES
U.S. government direct obligations (usually 2-10 years in duration)
NOTE: Interest on ALL U.S. treasury paper is exempt from state and local income
tax.
U.S. government direct obligations (10-30years in duration)
TREASURY BONDS
MORTGAGES
> 1 YEAR IN DURATION
A bank loan secured by real property (land, commercial, residential or
industrial). If the buyer defaults, lender forecloses and receives title.
Many varieties: Adustable rate or ARM (reset annually at 90 day
bill rate or other benchmark + a set risk premium
Fixed rate-rate fixed for life of loan ( 15-30 yrs)
Active secondary market caused by SECURITIZATION
FINANCIAL INSTRUMENTS CONTD.
CAPITAL MKT INSTRUMENT
MUNICIPAL BONDS
“MUNYS”
DESCRIPTION
Bonds or notes issued by a state of local government.
General obligation (GO) Backed by taxes (”Full faith and credit”)
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Muny issuers may be
a state, city, county,
agency, University etc.
$1000 par semi-annual pay
CORPORATE BONDS
$1000 par
Interest paid semi-annually
normally.
Revenue:
IDR:
Backed by tolls or other revenue
Issued by a municipality for a corporation
Exempt from Federal income tax. Some issues may also be
exempt from state and/or local income tax (“Triple tax free”)
Long term debt instruments of large corporations.
Mortgage bonds:
1st., 2nd., etc secured by real property
Equipment Trust Certificates secured by chattels like airplanes
Debentures –unsecured except by earning power of corporation
Interest on corporate debt is tax deductible to U.S. corporations
PAR= $1000
COUPON= stated interest rate (8% = $80) Paid SEMIANNUALLY
MATURITY = stated redemption date
SINKING FUND= prepayment of issue prior to maturity
LEASES
Debt obligation of individuals or corporations. May be bundled
into a portfolio and securitized such as a package of leases issued
by GMAC under standardized terms.
PREFERRED STOCKS
Par variable
Dividend fixed.
No maturity
Pfds are “quasi debt”
A unlimited maturity quasi-debt instrument with a fixed dividend
At present 70% of dividend income on preferred stocks owned by
other U.S. corporations is tax free (the intercorp. Dividend exclusion)
Preferred dividend payments are NOT deductible to the issuer
Dividends are fixed. Most issues are CUMULATIVE.
COMMON STOCK
“Residual Equity” or ownership capital of a corporation.
Dividends are declared by the board and vary with profitability
(earnings per common share).
Excess profits after payment of all expenses and dividends go to
Retained earnings which is part of shareholder’s equity capital.
CS holders own the
Corporation and vote
at annual meeting
The Board of Directors is elected by shareowners.
Shares of common stock are traded on exchanges such as the New York Stock
Exchange (“The Big Board”), regional exchanges and NASDAQ (National
Association of Securities Dealers Automated Quotation system) which is a
global intranet.
All instruments today are linked in a global marketplace.
INTEREST RATES: FIN 3303 (CH 6 – 8 of your text)
CHAPTER 6: THE LEVEL OF INTEREST RATES
INTEREST
The PRICE of borrowed money. It is also the intersection of the SUPPLY and
DEMAND curve for CAPITAL. There are MANY interest rates in our economy.
All interest rates are based on the U. S. Treasury bonds, notes and bills which
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Are free of default risk and are considered the safest financial instrument.
INTEREST RATE TRENDS
See Exhibit 6-7 on p. 141.
What caused rates to surge in 1980? What are rates now?
INTEREST AND INFLATION
See Exhibit 6-4 p. 138
Interest rates consist of two parts:
A. A so called risk free rate, and
B. A set of risk premiums which include
 Duration or maturity risk. Normally, longer duration instruments carry
higher interest coupons (see liquidity risk below)
 Premium for inflation (purchasing power risk)
 Default risk
 Liquidity risk
 Currency risk in international change
 Political risk including tax rates
CHAPTER 7: THE TERM STRUCTURE OF INTEREST RATES
YIELD CURVE
See Exhibit 7-2 p. 148
Note a “normal” yield curve is upward sloping to the right as in Jan. 94.
The 1981 curve is called an “inverted yield curve.” This is a serious economic
condition in which short term rates are higher than long term rates. A “flat” yield
curve is almost as bad as inverted curve (see Dec. 1994).
Using the excel spreadsheet on my web site, EACH TEAM should prepare the
current yield curve for U.S. Treasury bonds, notes and bills for class.
What factors cause the yield curve to change shape? What is the shape now?
DEFAULT RISK
Default risk in the case of a Corporate or Municipal bond is the risk of bankruptcy
due to non payment of a scheduled interest or principal payment. In a corporate bond,
the Trustee named in the indenture will initiate Ch. 11 bankruptcy proceedings in
Federal Bankruptcy court on behalf of all bondholders in event of default.
BOND RATINGS
See text pp. 158-159
Rating agencies include Moody’s Investors Service and Standard and Poors Corp.
These agencies rate bonds on a scale like a grade ranging from AAA to C. They
charge a fee for this service so some bonds may be nonrated because the corporation
or municipality did not choose to pay for a rating
INTEREST RATES contd.
TAXABILITY OF INTEREST
Article I of the U.S. Constitution prohibits the Federal Government from taxing the
States. Therefore interest on all Municipal bonds (local, state, County and agency)
is not subject to Federal income tax. Similarly, states cannot tax interest on Federal
securities. Therefore U.S. Treasury bonds are not subject to state income or excise
tax.
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INTEREST RATE CONCEPTS FOR REVIEW AND DISCUSSION IN CLASS
See questions on p. 167 of text. Plan to discuss q. 1, 2, 14.
The concept of “Risk Premium”
Risk free rate:
90 day bills
All other rates trade off Treasuries
Corp bond ratings:
AAA, AA, ETC.
What determines interest rates?
Supply and Demand for capital worldwide. The Fed cannot dictate rates.
Inflation
What is the relationship between inflation and economic growth?
Business risk
Track record
Assets – collateral
Competitive environment
Market risk
Expectations and uncertainty
Capital costs – passbook savings + X = interest rate charged on loans
Balance of trade -current account
If imports are > exports over time this can impact interest rate
THE ROLE OF THE FED: FIN 3303 TEXT Ch. 8
Commercial Banks and now all Depository Institutions are regulated by the Federal Reserve with headquarters in
Washington D.C. and 12 branches scattered about the country. The Fed was created just before WWI in 1913. The Fed is
considered one of the most powerful regulatory agencies in the U.S. The Fed Chairman is considered the most powerful
man in the country next to the U.S. President.
How does the Fed impact interest rates? The Fed does not set interest rates. In a capitalist or free market economy the
Central Bank can only influence rates. The only rate set by the Fed is the discount rate to member banks.
FED POLICY TOOLS
SEE P. 177-194
Reserve Requirements
(reg D) Infrequently used but VERY powerful.
Open Market Operations Most used tool. Explain impact of a SALE and a PURCHASE of
U. S. TREAS. BONDS, NOTES OR BILLS on the money supply.
Discount window policy (reg. A) Borrowing at Fed Window is less important than it once was.
Now banks borrow from each other. This is called FED FUNDS
and the Fed Funds rate is the interbank loan rate.
Moral suasion
Attempts by Fed Governors to influence public opinion
5. Margin Requirements
Margin requirements (G, T, U, and X) are set by the Fed for all security
and credit controls
brokerage firms. This is changed infrequently and is currently
50% on most security purchases. Note that reg Q is no longer in force.
See p. 172 of text for a list of current Fed regulations.
ORGANIZATION OF THE FED
12 REGONAL FEDERAL RESERVE BANKS
See map on p. 93 of text
Our Fed branch is in Atlanta
BOARD OF GOVERNORS
FEDERAL OPEN MARKET COMMITTEE (FOMC)
See p. 95
14 year term (1 expires every 2 years)
FED INDEPENDENCE
The Fed Chairman is often said to be the second most
powerful person in the U.S. next to the President. The Fed
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is funded by Congress, however and the Chairman
regularly testifies on Capitol Hill on monetary policy
issues.
MONETARY POLICY
U.S. Commercial banks may be chartered on a Federal or State basis. This is called a “dual” system which is unique to
the U.S. (see table on p. 90 showing charters up to 1914 when the Fed was created). Banks can change their charter.
They are still subject to regulation by the Fed but the audit responsibility changes from the Comptroller of the Currency to
the States.
Monetary policy encompasses all the Fed policy tools shown above. In a narrow sense, the Fed is charged with managing
the money supply (M-1 or M-2). Currency (Federal Reserve Notes) are a small part of M-1. Money in circulation is
determined by the Treasury Department. The Fed acts as the agent for the Treasury in destroying old or worn out bills or
coins. The majority of the money supply consists of demand deposits. The Fed has the ability to manage this through
reserve requirements but has been reluctant to do so in recent years.
Throughout history there are examples of economies where hyper inflation was brought about by excessive growth in
monetary aggregates, usually where the central government printed currency to pay off debts. The two best examples in
the 20th. Century are Post WWI Germany, and Argentina under the rule of dictator Juan Peron.
The objectives of monetary policy have varied with the composition of the Federal Reserve Board of Governors.
Generally policy goals today are considered to be high employment (low unemployment), steady economic growth, and
low inflation. Monetary policy may conflict with fiscal policy. Fiscal policy includes the budget actions of the Congress
which can affect budget surpluses or deficits. In the case of a budget deficit, the Secretary of the Treasury sells U.S.
Treasury bonds, notes or bills to cover the deficit. The Federal Reserve acts as agent for the U.S. Treasury in the regular
sale of Treasury securities which are sold by auction bid.
OTHER REGULATORY BODIES
Securities and Exchange Commission. Created in 1932 as one of the earliest pieces of New Deal legislation. The SEC
regulates all offerings of corporate bonds and common stock, regulates broker / dealers, and monitors merger activity
although any antitrust prosecution is handled by the U.S. Dept. of Justice.
State Insurance Commissioners. All insurance companies in the U.S. are regulated by the states. Primary regulatory
authority rests with the “home” state where the home office of the insurance company resides.
NCUA (National Credit Union Assn). Credit Unions are subject to dual regulation. If “Federal” is in the name, it is a
Federally chartered credit union. Credit unions are “mutual” organizations (owned by depositors). Management has been
typically lower quality than commercial banks. As a result many states limit credit union investments to direct obligations
of the U.S. Government.
FTC (Federal Trade Commission) Created to regulate interstate commerce, the FTC is involved in interstate mergers,
letters of credit, interstate marketing and a variety of other business activities
UNDERSTANDING BANK FINANCIAL STATEMENTS
This section is designed to help you review the financial statements for your team project.
In your project you may use the following SEC documents:
10K or annual report
Try and get the last 5 years if possible. Use the most recent statement since earlier reports are
not pro-forma for mergers or acquisitions.
10Q or quarterly report Corporations in the U.S. report results quarterly. The 10Q will provide you with updated data
since the last audited annual report. This information is NOT required for your analysis but is
valuable information. Note that quarterly data is not audited and is subject to restatement.
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Proxy
The proxy must be mailed to shareholders prior to the annual meeting. The SEC requires
that all public corporations hold an annual meeting of shareholders annually. The proxy
provides important information not available in other sources including: executive salaries,
benefits and shares owned, stock price performance, biographies on officers and directors,
and stock option information.
Prospecti
A prospectus is issued when a company does an initial public offering or a secondary offering
of common stock. A prospectus is the only form of “advertising” permitted by the SEC in a
new issue of common. A recent prospectus includes management forecasts and data on lines of
business that is not normally in the 10K or annual report.
Indentures
An indenture is issued when a company issues corporate bonds. The indenture is the contract
between the corporation and the bondholder and lists all the terms of the issue.
You will primarily work with annual audited reports and 10Ks. FIN 4313 STUDENTS WILL ALSO USE 10Qs
BALANCE SHEET
In accounting you studied the balance sheet of an industrial corporation. It is structured as follows:
INDUSTRIAL CORP.
ASSETS
LIABILITIES
< 1 YEAR
CURRENT ASSETS
CURRENT LIABILITIES

LONG TERM ASSETS
LONG TERM LIABILITIES
SHAREHOLDER’S EQUITY
1 YEAR
A bank balance sheet is similar but more complex::
COMML. BANK
ASSETS
LIABILITIES
short term
Vault cash
Required reserves at the Fed
Fed funds sold
Excess reserves
Investments –Treasury bonds, notes, bills
Short term loans
Fixed assets such as branch offices & ATMs
long term
Term loans (1-5 years)
Long term loans such as mortgages (> 10 years)
** Loan loss reserves are part of shareholder’s equity capital
Demand deposits
Passbook savings
Fed Funds purchased
Consumer CDs
Reserves ** and Shareholders
Equity
UNDERSTANDING BANK FINANCIAL STATEMENTS CONTD.
BALANCE SHEET CONTD.
In a depository institution a LOAN is an ASSET and a DEPOSIT is a LIABILITY.
ASSETS FALL INTO 3 CATEGORIES:
1. Reserves
2. Investments (held in liquid treasuries primarily)
3. Loans
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Loans provide the highest return. The bank must balance liquidity needs with need to earn a high return for the
shareholders. In a bank, safety and regulatory considerations have a higher priority than achieving high returns.
LIABILITIES FALL INTO 2 CATEGORIES
1. Deposits
2. Capital (Shareholder’s equity and reserves for bad loans)
INCOME STATEMENT
In an industrial corporation, revenues are expressed primarily on one line labeled sales.
In a bank revenues are achieved in two principal ways:
1. Interest income from loans and investments
2. Fees
A bank can increase its profit margin by:
1. Increasing the “spread” between average cost of funds and average return on loans or investments. This
spread is called “Net Interest Margin.”
2. Increasing fees. Fees can encompass areas such as money management, minimum balance fees, overdraft
charges etc.
In an industrial company the most important ratio from the standpoint of the shareholder is return on investment ROE.
ROE = net income / shareholder’s equity capital. Net income is enhanced by increasing earning assets. Look at the
balance sheet on the previous page. Does a bank earn a return on “brick and mortar” for a marble main office and
expensive branches? The answer is yes but the return is low. That is why banks have done sale leasebacks of physical
facilities in order to free up cash to achieve a higher investment return.
Banks have a HIGHLY LEVERAGED balance sheet. In an industrial company, shareholder’s equity is usually a high
percentage of total capitalization. In a bank it may be 5% or less. Return on assets (ROA) is therefore quite low.
A well managed bank (usually called a “high performance” bank) achieves an ROE of at least 15% and a return on assets
of 1% or more.
LOSS RESERVES
Each quarter the Board of Directors of the bank estimates potential losses on the loan portfolio. In the quarterly statement
a charge is made on the income statement called Reserves for Loan Losses. This is an estimate. Reserves are part of
shareholder’s equity capital. The theory behind this is that shareholders should bear the brunt of loan losses and not
depositors.
UNDERSTANDING BANK FINANCIAL STATEMENTS CONTD.
At the end of the year, the bank reports total loan Chargeoffs in the 10K. These are the actual loan losses. Actual
chargeoffs are NOT an income statement charge. They are charged against reserves. If actual chargeoffs are LESS than
quarterly charges from income RESERVES, the size of the loan loss reserves will increase as a percentage of total loans.
The size of reserves as a percentage of total loans gives some idea of the conservatism of bank management. A high loss
reserve usually means a more conservative management style. However, it is important to bear in mind that different
kinds of loans carry significantly different loss ratios. For example, consumer credit card loans have very high default
rates and require high chargeoffs whereas conventional 20% down mortgages carry minimal risk in a rising real estate
market.
KEY RATIOS
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LOAN / DEPOSIT RATIO
On average, loans as a % of deposits should be in the 80-90% range.
Today many banks exceed this norm because deposits are not growing and
loans are being aggressively marketed. Clearly this cannot continue long.
RESERVES / LOANS
Loan loss reserves are a buffer against loan losses. Typically, the reserve
peaks prior to a recession. There is no set norm for this ratio since it varies
with loan mix.
INVESTMENTS / LOANS
Investments serve as a ready source of funds in event of deposit outflows.
Treasury securities can be sold on a next day settlement basis to raise cash.
There is no norm for this ratio and it is influenced by seasonal factors such
as tax payments.
ROA
Net income / total assets. As noted ROA > 1% is considered high
performance for a commercial bank. Thrifts tend to have a lower return.
ROE
Net income / shareholders equity capital (which includes reserves). An
ROE of 15%% is considered high performance. Thrifts tend to have lower
ROEs due to the lower net interest margin on mortgages. However the
trend toward securitization of mortgages has increased returns since thrifts
can sell their portfolio regularly raising funds to reloan the money and
keeping servicing income on the portfolio.
NET INTEREST MARGIN
While this ratio technically represents the spread or difference between cost
of funds and return on loans and investments, it is an average calculated
according to complex rules and can only be estimated by an outside
investor. Use the numbers provided by management in the annual report.
BOOK VALUE PER SHARE
Shareholders equity capital divided by common shares issued and
outstanding. BVPS grows as capital is reinvested. It decreases with serious
loan losses which are charged against reserves which are a part of
shareholder’s equity capital.
PRICE / BOOK
A key ratio in determining whether a bank is a potential “acquiree” or an
“acquiror.” A HIGH price / book enables a bank to buy other banks without
dilution. Price / book is more important than P/E for a bank.
PRICE / E.P.S (earnings) or P/E
The P/E ratio is a valuation measure. Banks trade at a discount to the
market P/E multiple since they are highly regulated and can be cyclical.
CHRONOLOGY OF IMPORTANT U.S. BANKING LEGISLATION
NOTE: There is additional important legislation affecting non-depository institutions
1863
National Banking Act
Created National Banks (Northern states only)
1913
Federal Reserve Act
Created Federal Reserve System
1927
McFadden Act
1933
Glass- Steagall Act
Required each bank to operate under branching restrictions
imposed by the state in which it operated. Effectively restricted
interstate mergers.
Created the FDIC (Federal Deposit Insurance)
Prohibited Commercial Banks from engaging in investment
banking. Weakened in recent years
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1933
1934
SEC ACT
SEC ACT 2
Created reporting requirements. Outlawed many practices.
Set methods for firms going public.
.
Prohibited most interstate bank acquisitions
1956
Bank Holding Co. Act
1961
INTEREST RATE ADJUSTMENT ACT
Extended interest rate regulations to thrifts for the first time.
No longer in force.
1970
Bank Holding Co. Act
Extended restrictions on bank holding companies
1980
DIDMCA—Depository Institutions
DeRegulation and Monetary Control Act
Phased out interest rate ceilings
Extended Fed reserve requirements to all depositories
Made Fed services (particularly check clearing) available to thrifts
1982
Garn-St Germain
Allowed Money money deposit accounts
Allowed interstate mergers of “troubled” institutions
1989
Financia l Instititions Reform
Recovery and Enforcement Act
FIRREA
Abolished the Federal Home Loan Bank and the FSLIC
Restructured the FDIC to include thrifts
Increased FDIC premiums
1991
Federal Deposit Insurance Corp.
Improvement Act (FDICA)
Risk based insurance premiums
Requires FDIC to monitor examiners closely with troubled banks
1994
Reigle-Neal Banking Act
Essentially allows interstate acquisitions of banks and branches
banking. Weakened in recent years.
1999-2000
PENDING
HR 10 Financial institution major reform bill
Pending legislation would repeal Glass Steagall and would
Permit many financial institutions to buy other institutions using the
Holding Company format.
NOTE: This is not a complete listing of key legislation. If primarily focuses on banking. Insurance regulation is handled
by each state and there is no Federal insurance regulatory agency.
MONEY CREATION: THE BANK T ACCOUNT MODEL
FIN 3303: SEE PP. 210 – 213 OF YOUR TEXT
10% RESERVE REQUIREMENT
While rates vary, reserve requirements are set by the Fed on both demand deposits and time
deposits. Deposits are a liability for a bank. Funds from deposits is invested in cash, reserves,
loans and investments
1. Assume a bank takes a deposit of $100,000.
Bank 1 must maintain cash or reserves of $10,000 or 10%.
Therefore 90% is lent out or invested and finds its way to another bank in the system.
2. Bank 2 receives a $90,000 deposit, maintains 10% reserves and lends $81,000
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3. Bank 3 receives a $81,000 deposit, maintains 10% reserves and lends $72,900
This process proceeds through the entire banking system.
n. Bank n receives a deposit of $1 million.
For the system as a whole, M-1 increases by 1/rr. In this example in the text, rr = 10%.
Therefore M-1 increases by $1 million on an initial deposit of $100,000.
OPEN MARKET OPERATIONS:
When the Fed sells bonds it is paid with a check. A sale removes cash from the system and is
contractionary. A purchase of T-bonds by the Fed is paid for with a check and injects money
into the system and is expansionary
FORMULAS
R
RR
= RR + ER
where RR = required reserves
ER = excess reserves
= rr x D
where rr = percentage reserve requirement set by the Fed
M
= C + D
where C = currency and D = deposits systemwide
DEPOSIT EXPANSION MULTIPLIER FOR THE BANKING SYSTEM
Deposit expansion from Federal reserve action (reserve requirements or open market purchases or
sale of U. S. Treasury bonds, notes or bills)
1/rr = Simple deposit multiplier
With a 20% reserve requirement, an injection of $1 MM by the Fed
into bank reserves results in an expansion in deposits in the entire
banking system by $5 MM (five fold expansion)
FIN 4313 READING MATERIAL
Some of this may be used in FIN 3303 on an
Introductory basis only
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IN FIN 4313 THE FOLLOWING PREREQUISITES ARE NECESSARY:
A. FIN 3403
B. FIN 3303
THESE COURSES MAY NOT BE TAKEN CONCURRENTLY
PROFICIENCY IN USE OF A FINANCIAL CALCULATOR IS REQUIRED
WE WILL USE THE TIBA2+
INTRODUCTORY MATERIAL
A. FINANCIAL INSTITUTIONS
We will begin by reviewing material from FIN 3303 on U.S. financial institutions.
The syllabus will assign additional readings dealing with international financial institutions, the
changing role of the institutions, and pending legislation.
Review legislation on p. 24 ABOVE and see pp. 20-21 of your text for FIN 4313.
Be sure and see table on pp. 456-459 of your text.
B. INTEREST RATE TRENDS AND THE YIELD CURVE
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TEXT CH. 6-7
There are 4 factors of production:
1. Land
2. Labor
3. Capital
4. Entrepreneurship
Interest is the cost of capital.
Rent is the cost of land and real property
Wages are the cost of labor.
Profit is the return to the investor for entrepreneurial and management input.
Assignment 1 on your Excel worksheet is the U.S. Treasury yield curve. This was introduced in
both FIN 3403 and 3303. Using a current WSJ, enter the data in the yellow cells.
We will also be looking at “Yield spreads” for Federal agency bonds, AAA, AA, A, and BAA
bonds which are considered “investment grade” or “bank qualified.” All agency and corporate
rates are above U.S. Treasury yield curve levels.
C. BOND MATH AND DURATION
ADDITIONAL REVIEW MATERIAL ON TVM AND BONDS IS IN THE FIRST SECTION
OF THE APPENDIX TO THESE LECTURE NOTES.
Assignment 2 provides a review of the TIBA2+ bond worksheet. In addition we will introduce
the concept of “Duration.” This is covered in CH 7 of your text readings.
Assignment 2 will have you solve yield to maturity and yield of call problems. We will also
look into AI or accrued interest in more depth.
BOND TERMINOLOGY (FIN 3403 review)

INDENTURE A contract between a U.S. corporation and bondholders specifying terms of a new bond
issue. This document is required by the SEC. The indenture specifies coupon, trustee, call provisions,
maturity, and other terms such as convertibility.
 TRUSTEE Institution (usually a bank) charged with enforcing terms of indenture. The trustee initiates
Ch11bankruptcy proceedings if coupon interest is not paid on time.
 COUPON The stated interest rate on a bond. Coupon is stated in percentage terms.
An 8% coupon is equal to $80 per year (8% times $1000 par). THE COUPON IS FIXED
FOR THE LIFE OF THE BOND. ALL CORPORATE BONDS WE WILL STUDY PAY
INTEREST SEMIANNUALLY. Each coupon in this example would be $40. All problems
will use semiannual coupons. Set bond spreadsheet for 2/Y
 COUPON IN DOLLARS
8% = $80 paid semiannually ($40 and $40)
 PAR Face value. $1000 FOR CORPORATE BONDS. ALL BONDS MATURE AT PAR.
NOTE: IF A BOND IS CALLED BEFORE MATURITY THERE IS USUALLY A
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CALL PREMIU (i.e. 103 call price means firm refunds issue at $1030 per bond.)
 PRICES OF BONDS ARE QUOTED IN % OF PAR -- 80% = $800. Your BOND WORKSHEET is in
% of par. If you solve a problem and the NPV is 92 this MUST be converted to dollars (i.e. $920)
 CURRENT YIELD Current percentage return :
$ COUPON / PRICE OF BOND
 YIELD TO MATURITY (YTM)
This is the TOTAL RETURN on the bond:
Current yield + capital gain (or loss)
 ACCRUED INCOME Interest due the SELLER of the bond based on the number of days since the last
coupon date. This is the last entry on your bond calculator (AI). The calculator uses a 365 day year for all
corporate bonds (ACT). In U.S. Government bonds, the calculator is set for 360 day year by pressing ACT
and ENTER. Calc should read 360.
NOTE: Since this is a corporate finance course, leave your calculator set for ACT (365 day year)
 DURATION A measure of sensitivity of a bond price to changing interest rates. Duration is a mix of
MATURITY and COUPON INCOME. Long maturity bonds generally have longer duration. Higher
COUPON bonds of the same maturity as a lower coupon issue will have shorter duration since the NPV of
the coupon income is greater. ASSIGNMENT 9 DEALS WITH DURATION
BOND CONCEPTS







At par Coupon rate = current yield = yield to maturity (YTM)
If a bond is selling ABOVE PAR , current yield will be > YTM. WHY?
Because if a bond is above par
(over $1000) and matures at $1000 you will incur a CAPITAL LOSS at maturity. This loss is incorporated
in YTM calculations.
If a bond is selling BELOW PAR you will have a gain upon maturity and YTM > current yield.
If interest rates DECLINE, bond PRICES INCREASE
A bonds YIELD TO MATURITY is ALWAYS EQUAL to interest rates on bonds of similar TYPE,
QUALITY AND MATURITY in the marketplace. In order for the YTM to equal the market rate, the bond
price adjusts to reflect current rates.
The NPV key on your calculator is the sum of two elements: the NPV of all semiannual interest coupons
(AN ANNUITY) and the NPV of the price at maturity or call. At maturity the bond will be worth $1000. If
the bond is called prior to maturity, the corporation may have to pay a call premium (say 103). This will be
disclosed in the indenture.
If you know a bond COUPON, MATURITY DATE, and the MARKET RATE on bonds of similar type,
maturity and quality, you can solve for NPV. This is how Wall Street Bond traders determine the price of a
bond (excluding accrued income and commission)
BOND WORKSHEET ON THE TIBA2+
P/Y = 2
SET P/Y TO 2 FOR ALL BOND PROBLEMS AND EXAM
N
= YEARS TO MATURITY
I
= INTEREST ON BONDS OF SIMILAR TYPE AND QUALITY (NOT COUPON)
PV
= CURRENT PRICE (NEGATIVE NUMBER)---WE SOLVE FOR THIS
PMT = DOLLAR VALUE OF SEMI ANNUAL COUPONS
FV
= $1000 OR REDEMPTION CALL PRICE (DISCUSSED LATER IN LECTURE)
EXAMPLE
SOLUTION USING TVM KEYS
WHAT IS ITS THEORETICAL VALUE? IT IS THE NPV OF ALL
CASH FLOWS DISCOUNTED AT THE MARKET PREVAILING \
INTEREST RATE FOR BONDS OF SIMILAR TYPE AND QUALITY
THIS INTEREST RATE IS 7.5%
SET P/Y = 2 AND CLEAR ALL REGISTERS
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MATURITY IS 25 YEARS
N=50 (25*2)
COUPON
= 8% THEREFORE PMT = $40 ($80/2 NO MINUS SIGN)
FV
= $1000 (par) FV may be CALL PRICE if bond is called.
I/Y
= 7.5 IMPORTANT: I/Y = market rate NOT coupon on bond
SOLVE FOR PV = $1064.17
BOND IS SELLING AT A PREMIUM TO PAR.
WHY?
On the next page we will look at the Bond Spreadsheet. It is recommended that in an exam if you are
asked to compute the theoretical price of a bond (NPV) use BOTH methods to check yourself.
In any exam question where you are asked to compute YIELD TO MATURITY or ACCRUED
INCOME you MUST use the Bond Spreadsheet. Be sure and clear all registers after pressing the CF
key. REMEMBER That PV in your solution will be a negative number since it is a cash outflow.
semiannual DOLLAR COUPON = INTEREST COUPON TIMES PAR ($1000) / 2
8%
= $80 PER YEAR
coupon + $40
SOLVING FOR YTM USING THE BOND WORKSHEET see sec. 5-2 IN TI BA2 MANUAL
Problem: Compute yield to maturity and accrued income for a 8% debenture with a
trade date of 6-30-97 and a maturity of 30 years from trade date. The purchase price on this bond
is 106.53
NOTE; ALL INPUTS IN SPREADSHEET ARE AS A % OF PAR
BOND VALUATION CONTD.
This is a step-by-step solution using your TI BAII + calculator:
ENTER: 2ND BOND to enter the bond worksheet
SDT
= SETTLEMENT DATE (3 days from TRADE DATE for corporate issues)
July 3, 1997 is entered as: 7.0397. This is when you BUY the bond.
DOWN ARROW
CPN
= COUPON RATE IN PERCENT = 8%
ENTER 8
DOWN ARROW
RDT
= REDEMPTION DATE
MATURITY OR CALL DATE
30 YEARS FROM 6-30-97
=
6-30-27
ENTER as: 6.3027
This is when bond matures or is called.
TI CALCULATOR HANDLES THE MILLENIUM PROBLEM
DOWN ARROW
RV
= REDEMPTION VALUE
AT MATURITY THIS IS ALWAYS 100
AS A PERCENT OF PAR
100 = 100% OF PAR
DO NOT enter 1000 here.
IF BOND IS CALLED PRIOR TO
MATURITY THIS IS CALLED A
“CALLABLE” BOND
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REDEMPTION CALL IS ALWAYS
ABOVE PAR --SAY 103
SET ACT and forget
CORP BONDS USE ACT (ACTUAL 365 DAY YEAR) ALL
EXAM PROBLEMS WILL USE ACT
MAKE SURE CALCULATOR IS SET FOR SEMIANNUAL COUPON
= 2/Y
SKIP SOWN TO PRI (PRI)
= 106.53
IMPORTANT: BE SURE AND CONVERT ANSWER FROM PERCENT OR PAR TO DOLLAR
PRICE: BOND PRICE IN DOLLAR TERMS IS $1065.30
AI
= ACCRUED INCOME
= .0652
Accrued income is the interest payable to the seller reflecting accrued interest from the last
coupon to settlement date.
If you buy a bond with coupons on January 1 and June 30 on March 30 you (THE BUYER)
owe the seller half your next coupon payment. This is called accrued income and is added to
your cost when you buy the bond. The sales commission is also added.
YOU SETTLED ON THE BOND 3 DAYS AFTER THE COUPON PAYMENT
Therefore accrued income is 3 days. Your calculator will automatically calculate AI.
MULTIPLY THE ANSWER IN AI BY TEN TO GET THE DOLLAR VALUE OF AI.
80/365.25
21.9 CENTS PER DAY X 3 DAYS =
66 CENTs
UNDERSTANDING CONVERTIBLE BONDS AND PREFERRED STOCKS
Convertibles are a “Hybrid” security in two parts:
A. In a convertible bond, there is a bond protion with all the characteristics of “Straignt” debt.
B. The convert also has common stock characteristics. The bond is convertible into common at a set or fixed price.
Once the price of the common stock is trading ABOVE the CONVERSION PRICE, the bond will trade in lockstep
with the common.
CONVERTIBLE TERMS
CONVERSION PRICE
Price at which bond or convertible perferred is convertible to common.
Typically, the conversion price will be set 15-20% above the common
Price in a new issue on the date when the bond starts trading.
CONVERSION RATIO
PAR DIVIDED BY CONVERSION PRICE
In a bond this is always $1000 / cv. Price
THEORETICAL VALUE
OR
CONVERSION VALUE
Estimated value of the common stock equivalent in the bond.
CONVERSION RATIO TIMES MARKET PRICE OF COMMON
(only applies if the common stock is “IN THE MONEY” and is
Trading above conversion price
EXAMPLE:
A bond is convertible into common at $30
The common ot the date of the bond issuance is trading at $25
Two years later the common is trading at 40.
COMPUTE the conversion ratio and theoretical value
CR = 1000/30 = 33.333 common shares per bond
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TV = 33.333 x $40 = $1333
The bond is trading above par and will move in lockstep
With the common and not with interest rates.
If the common rises to $50 the bond will sell at a TV of $1666.67
CONVERSION PREMIUM
Convertible securities are attractive instruments:
A. They have priority to income and assets over the common
B. The bond has a fixed maturitry at which it is worth $1000
C. The yield on the bond is usually higher than the common dividend zero which
may actually be zero in many high tech companies
For these reasons, converts frequwntly sell aove theoretical value
IN THE EXAMPLE ABOVE, ASSUME THE BOND IS TRADING AT $1500
AND TV = 1333
THE CONVERSION PREMIUM = (1500 – 1333)/ 1333 = 12.5%
CALL
The indenture provides that a bond can be called whether it is “straight” debt or a
convert. In the case of straight debt, the call is occasioned almost always by a
Decline in rates which allows the CFO to save money by calling the issue and
replacing it with a bond with a lower coupon.
In a convert, calling the issue has another effect. IF THE COMMON IS SELLING
ABOVE CONVERSION PRICE and a convertible bond is called the effect is :
A. Say the bond is selling at $1333 (133 on your financial calculator) and is called at
105. Do you lose $280? No.
B. The theoretical value of the bond reflects the common stock equivalent value.
Your bond is convertible into 33.33 shares of common. The common is trading
at $40 per shares making the theoretical value $`1333. If the bond is called you
would CONVERT THE BOND TO COMMON.
C. A CONVERTIBLE ISSUE IS “SELF LIQUIDATING”
What this means is that all bonds convert to common.
The corporation no longer has to pay interest on the bond issue.
The number of common shares increase however, possibly causing dilution.
PORTFOLIO STRATEGY
Every financial institution manages a portfolio.



Banks manage a portfolio of bonds and loans
Mutual funds manage portfolios ranging from money market instruments, to stocks in one sector, to international
bonds and stocks.
Insurance companies manage large defined benefit pension plans which must conform to return assumptions set by an
actuary
Your book tends to focus (excessively I think) on Commercial Bank management. While banks are
very important, they are not as significant as they were 10 years ago because:
 Mergers and acquisitions are creating conglomerate financial institutions requiring broader knowledge than loan

portfolio diversification
Speaking as a senior officer of a bank –mush of banking is not rocket science
Assignments 4 and 5 ask you to develop a mission statement and strategy for a portfolio.
Investing is hard work. Stock picking is the fun part. Financial instrument prices are dependent on a
host of external factors some of which are predictable or projectable and some are not:
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



Interest rates and general macroeconomic activity levels
Regulatory and legal developments (including taxes)
Currency levels and exchange rates
Monetary and fiscal policy
Financial instruments are also affected by internal factors unique to the company or enterprise
including:



Sales and earnings growth
E.P.S. comparisons reflecting M&A and divestiture activity
Market expectations and psychology
MISSION STATEMENTS AND STRATEGY
Sound decision making entails the careful consideration of as much information as possible.
One of the key problems of the electronic age is not that we lack data, but rather that we are inundated
with information. Management requires intuitive insight. It is necessary to make a decision based on
incomplete information. This takes courage and insight. Investing is like that.
Institutions today love “Mission Statements.” This has become so pervasive as to seem useless,
outmoded or archane. However, this is a worthwhile exercise. In a financial institution, management
serves many masters. In a mutual fund they must answer to:



The client or investor. In a MUTUAL company, the investor, depositor, or policyholder OWNS the company since
there are no shareholders. The Board of a mutual fund represents the investors and is elected by them.
The regulators such as the SEC, state examiners, and bodies such as the NASD. Personnel must be licensed. They
must be fingerprinted and checked by the FBI. And don’t forget the auditors.
The competition. This is a tough business. There are thousands of funds out there all purporting to outperform the
next guy. This makes being an NFL coach seem positively easy.
TOP DOWN STRATEGY AND ANALYSIS
Markets are like the ocean. There are TIDES, WAVES and RIPPLES. Day traders play with the
ripples. The big money is made picking the tidal action.
Megatrends are long term forces that impact markets. Examples include:
 The graying of America. As the baby boomers age opportunities to serve this demographic
segment continue to grow.
 Health care products of all kinds
 Retirement investing
 Financial planning
 Increased leisure time.
 The “Global Village”
A successful manager reads widely. How else do you expect to out-think the competition on a global
basis?
Top down strategy statements seek to distill a variety of factors into action plans that will determine
portfolio strategy. These include:
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


Specific macroeconomic forecasts. Obviously interest rates will have an impact on all financial
investments as will growth in GDP.
Which industries or sectors will perform best in this environment? Why?
How is sector rotation influenced by the stage in the economic cycle? Early cycle stocks tend to
do best in the early stages of recovery and usually include autos, appliances and home building.
Late cycle stocks do well in a higher interest rate environment (some financial institutions). Some
groups are steady growers like pharmaceuticals that are more dependent on innovation and
product development than the economic cycle.
What sectors or industries do you think are appropriate for your fund NOW?
BOTTOMS UP ANALYSIS
One of the hardest lessons to learn in the financial markets is that experience counts because as Yogi
Berra said “It’s deja vu all over again.”
Story stocks are fun. These are stocks with no earnings but a great story that sucks in the
unsophisticated investor. Internet stocks are a current example of this. Yes the growth is there. Wall
Street looks at EARNINGS PER SHARE growth. Without a bottom line, a stock will wither.
The stock picker has thousands of stocks to choose from. How to you narrow the selection down?
Here are some suggestions:
1. Stick with quality. You do this when you shop for clothes. Choose seasoned companies with an
established track record.
BOTTOMS UP ANALYSIS contd.
2. Have specific FUNDAMENTAL criteria for selection that are quantitative:
 Financial ratio criteria such as a low debt equity ratio or current ratio.
 E.P.S. growth of a certain minimum level
 Management must own a certain percentage of outstanding common.
 There should be limited or no insider selling
Institutional investors spend YEARS developing a unique set of criteria that defines their
investment “style.” Some are simplistically labeled as “growth” investors and some are called
“value” investors. Why not both? Some buy “blue chips.” Others but emerging growth
companies.
3. What about TECHNICAL analysis? This is the science of charting and price action.
Fundamentals are important. However, timing (while very difficult) is also important.
4. PORTFOLIO CONSTRUCTION is important. In a mutual fund this MUST be stated in the
prospectus and violating these guidelines is a CRIMINAL offense.
 Do you want a minimum or maximum market capitalization? Small stocks grow faster
but are more volatile.
 Should all stocks pay a dividend? If so what is your minimum yield requirement?
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


What is the maximum percentage position?
How much cash will you hold (minimum and maximum)?
What is your BETA?
STOCKPICKING (assignment 6)
Investing should be FUN! Do not let it intimidate you. There is no wrong answer (unless you are
playing with you own money and you lose it all!)
Here are some general tips:
1. Be well diversified by industry or sector. Pay attention to the macroeconomic cycle however.
Some groups do better at different stages of the cycle.
2. I suggest you limit yourself to U.S. companies for the following reasons:
 Predicting foreign currency effect is almost impossible
 Accounting in many foreign economies is unreliable
 U.S. companies can be found that provide solid international growth exposure
3. Look for value. Growth is great but do not overpay for it. I like to buy stocks where the P/E is
less than one times the growth rate. If a company is growing at 20%, I will not pay more than 20
times earnings. It works because it keeps you out of trouble.
4. Be observant. Stick with what you know. Peter Lynch suggests that garbage is a great
investment for example. It is not sexy. The fact is, however, that companies like Waste
Management are a great way to capitalize on the megatrend of the throw away society.
5. Look for “fallen angels.” I like to buy GREAT companies that have suffered a TEMPORARY
price dislocation due to a CORRECTIBLE problem. Wall Street is short term oriented. You
must train yourself to march to a different drummer. This is hard. Ignore the journalists (I call
them Financial Papparazzi). They merely repeat what they heard because they have a degree in
English literature. You are a finance pro. Think for yourself!!!
SCREENING FOR IDEAS
Software to assist in screening stocks has improved dramatically in recent years.
An example of software that is reasonably priced and available to the general public is “Telescan.” The pros use much
more expensive software such as the “Compustat” database and the multiple model FactSet database. The difference
between these databases is the number of companies and the number of data elements. Telecasn offers about 1500 or so
of the larger U.S. stocks that are actively traded. Compustat, on the other hand includes over 20,000 stocks and 20 years
of financial data (10 years of prices) as well as thousands of financial items.
Stock screening is a good discipline. It forces you to define specific criteria that you wish to include in your universe of
possible stocks. The screening model will exclude all stocks that do not fit your criteria.
EXAMPLE:
You specify the following criteria (based on your portfolio strategy statement)
A. SIZE AND GROWTH CRITERIA
1. Market cap > $100MM
2. Sales > $200MM
3. DPS > 0
4. Historical 5 year EPS growth > .15
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B. PROFITABILITY RATIOS
5. Historical 5 year Sales growth > .05
6. Pretax margin > .075
7. ROE > .12
C. LIQUIDITY AND LEVERAGE RATIOS
8. Debt / equity < .4
9. Times interest earned > 2.5
D. VALUATION RATIOS
10. P/E < 5 yr projected EPS growth rate times 100
11. Price < 80% of LTM high (i.e. stock is 20% below last 12 month high price)
In a screening program, as you add variables, the UNIVERSE of possible candidates declines exponentially.
Typically, you begin with a few criteria and add more as you go. The idea is to get a manageable list of stocks to analyze
using fundamental ratio analysis and charting. This is the way pros pick ALL stocks. You should too. This method
assures that the same quality criteria are utilized .
Most individual investors fall victim to “Story Stocks.” Examples include America On Line and Starbucks Coffee. The
story is good. The trouble is that the valuations are so far out of line that any minor deviation from trend line growth
results is a very sharp sell off.
It is OK to buy growth stocks. The key is to find “fallen angels.” There are ALWAYS cheap stocks to buy in any market
environment. Usually you can find better values in the smaller, less researched companies. A “Blue chip” does not need
to be a Dow Stock. Many smaller companies are solid growers that are well managed and fit all the quality criteria. Go
the road less travelled and you will prosper.
CONSTRUCTING YOUR PORTFOLIO
Using the Excel spreadsheet, enter the data on 10 stocks. Leave no cells blank. Check for entry errors.
Once you have entered your data, look for computer generated diagnostics and see instructor. Pay attention to valuation.
The model will warn you if the DDM valuation is out of line. If so, consider another company in the same sector.
BANK MERGER AND ACQUISITION ANALYSIS
SEE ASSIGNMENT 8 IN FIN 4313 ASSIGNMENT EXCEL DISK
Financial institutions are currently engaged in a frenzy of merger and acquisition activity. The “acquiror” institutions are
characterized by a high P/E ratio, a high price to book, and a high growth rate in earnings leading to a superior stock
price. Maximization of shareholder value has taken on an entirely new meaning in this industry.
Banks are buying other banks, thrifts, broker dealers, insurance brokers, and insurance companies. Most of the
acquisitions use the acquiror bank stock as “currency.” Under the IRS code, a stock “swap” (exchange of common stock
in acquiring companies for common stock in acquired companies) is a tax free transaction. Capital gains are not triggered
unless investor sells shares received in the swap which assume the basis of the old stock.
The Holding Company format is the organizational structure of choice since it allows maximum flexibility and has proven
to be a way to bypass many of the Depression Era laws and antitrust laws limiting merger activity. A holding company
such as Citigroup owns stock in subsidiaries or affiliates. Citigroup controls Citibank, Travelers Insurance and Solomon
Smith Barney (a large underwriter/broker/dealer).
In the example below we will show how an acquisition takes place resulting in “accretive” earnings to the acquiror bank.
Issuing more common shares would ordinarily result in lower earnings per share. In many bank mergers, however, the
combination of large disparities in P/E and price / BVPS ratios, and significant layoffs and cost savings after the deal,
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have resulted in pro-forma improvement in E.P.S. This in turn increases the stock price of the acquiror bank which allows
them to turn around and make another acquisition.
SCENARIO:
BANK B PURCHASES BANK A USING STOCK
AGREES TO PURCHASE BANK A FOR $30 PER SHARE (A 20% PREMIUM)
RATIO = 2 SHARES OF BANK A FOR 1 SHARE OF BANK B (0.5 MM SHS ISSUED)
STOCK PRICE
ASSETS
SHARES OUT
COM. SHAREHOLDER'S EQUITY
GOODWILL
BOOK VALUE / SH ( BVPS)
PRICE / BVPS
NET INCOME
E.P.S.
P/E
BANK A
ACQUIREE
BANK B
ACQUIROR
PRO FORMA
COMBINED
$25
$500 MILLION
1 MILLION
$20 MILLION
$0
$20
1.25X
$2.5 MM
$2.50
10X
$60
$ 2 BILLION
3 MILLION
$30 MILLION
$5 MILLION
$30
2.0X
9 MILLION
$3.00
20X
BANK B ONLY
$2.5 BILLION
3.5 MM
_________________
_________________
_________________
_________________
_________________
_________________
_________________
Enter pro-forma combined data in blanks to right.
THIS IS AN ACCRETIVE" ACQUISITION." This means that E.P.S. increases as a result of this stock swap
acquisition. What is the pro-forma combined E.P.S.?
Bank B is paying a premium over book for Bank A. This difference is accounted for as "Goodwill" on the asset
side of the balance sheet for Bank A. Acquiror Banks will have Goodwill (often in large amounts) on their balance
sheet. This is one identifying characteristic of an Acquiror Bank.
REFER TO THE EXCEL SPREADSHEET ASSIGNMENT 8. In this assignment you will enter data on two real banks.
The acquiror will be the bank you did in assignment 7. The acquiree will be a smaller bank you pick.
SECURITIZATION
Introduction
Please refer to text pp. 427-28
The Thrift crisis of the late 70s and early 80s led to the failure of many Thrifts and scandals such as
“Whitewater.” Subsequent legislation such as FIRREA sought to reform regulatory oversight and
merged the FDIC and bankrupt FSLIC insurance funds. The Thrift crisis cost American taxpayers in
excess of $300 billion. Unfortunately the reform measures have failed to address the root cause of
this crisis which is disintermediation.
What is disintermediation? (see text pp. 36-37)
Disintermediation can occur with any financial institution. In a depository (bank, thrift, credit union)
disintermediation usually occurs when interest rates on competing investments (such as money
market mutual funds) exceed rates on “passbook” deposit accounts or CDs. This leads depositors to
withdraw funds. If the assets of the institution are illiquid (such as long term fixed rate mortgages),
these withdrawals, however orderly, may cause the institution to fail.
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Disintermediation today is more rapid and more prevalent due to investor sophistication and the
proliferation of new financial instruments, mutual funds, and new forms of NOW accounts.
Can disintermediation be prevented?
In the immediate Post-WWII environment, the Fed set interest rates on all deposit accounts using
Regulation Q. This was a form of price controls. Interest rates are no longer regulated because in a
free market economy, money will flow out of the country if more competitive returns are available
elsewhere.
Ironically, it has been Wall Street, not Congress, that has provided a partial solution to this problem.
The solution has been to permit institutions such as Thrifts to package illiquid assets such a fixed rate
mortgages, have them guaranteed by an Federal Agency such as GNMA (Government National
Mortgage Assn., and then GNMA “Passthrough” bonds are sold to investors. In many cases, the very
banks / thrifts that sold the loans, replace the asset with GNMA bonds. This changes an illiquid asset
on the balance sheet to a Government agency bond that can be sold on next day settlement.
See diagram on p. 428 of text. In the case of packaged mortgages, GNMA guarantees principal and
interest for investors. The loans are packaged in blocks typically of $100 million and are sold by a
Wall Street investment banking firm to individual investors and institutions. Passthrough bonds pay
interest and principal monthly.
Note that securitization allows a bank to make a loan, package it, sell it, and repeat the process over
again perhaps as often as once a week. The bank gets fee income with each loan and may retain loan
servicing rights.
PUT AND CALL OPTIONS
PUT = OPTION TO SELL
CALL=OPTION TO BUY
Standardized options are money market instruments (expire in < 1 yr)
STRIKE
=
OPTION EXERCISE PRICE. FIXED FOR LIFE OF CONTRACT
STOCK PRICE Market price of underlying common.
CONTRACT = 100 shares
3 THINGS CAN HAPPEN TO AN OPTION CONTRACT:
1. You can exercise it
2. You can sell it prior to expiration
3. You can let it expire worthless
All options are worthless on expiration
The price of the option is NOT the same as the price of the underlying stock. The option price is the premium you would
pay (in a purchase situation) for 1 share. The minimum purchase is 1 contract or 100 shares. The strike price and the
price of the stock must be compared to see if contract is “in the money.”
IF A PUT STRIKE > PRICE OF STOCK it is IN THE MONEY
IF A PUT STRIKE < PRICE OF STOCK it is OUT OF THE MONEY
IF A CALL STRIKE > PRICE OF STOCK it is OUT OF THE MONEY
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IF A CALL STRIKE < PRICE OF STOCK it is IN THE MONEY
DIAGRAM IT: PUT OR CALL STOCK PRICE
OPTION PRICE X 100 SHS = PREMIUM
OPTION STRIKE
DETERMINE IS OPTION IS IN THE MONEY OR OUT OF MONEY
PROFIT OR LOSS EQUALS
1. PREMIUM PAID FOR OPTION CONTRACT (in case of a purchase)
PLUS
2. PROFIT OR LOSS AT EXPIRATION. This is only the case if the option is IN THE MONEY
Otherwise, it expires worthless
OR
1. PREMIUM RECEIVED FOR OPTION CONTRACT (in case of a sale of an option)
PLUS
2. PROFIT OR LOSS AT EXPIRATION This is only the case if the option is IN THE MONEY
Otherwise, it expires worthless
A COVERED CONTRACT is an option that is backed by stock you own. If you own 100 shares, you can write 10
covered contracts (puts or calls). Why would you do this.
IN THIS COURSE OUR FOCUS IS ON OPTIONS PRIMARILY TO HEDGE RISK
 A put is a form is a form of “portfolio insurance” since it limits loss to a specific level
 Selling a call gives seller premium income. Most sales are “out of the money” Seller is betting that the stock will not
appreciate to strike before expiration. If it is in the money, seller will have his stock purchased away at strike price.
INDEX OPTIONS are options based on an index such as the OEX (S&P 500) –500 stocks or the OEX (S&P 100)-100
stocks or the DJIA (30 stocks)
LEAPS ARE LONG TERM OPTION CONTRACTS (1-2 years usually)
READING PUT AND CALL OPTION QUOTES
A. Index options
-- Index close must be checked in box usually on upper left of page or section in WSJ
Quote is checked by looking up date and strike price under appropriate index option
Two quotes are given on separate lines C=call
P=put
B. Individual stock options -- Price in LEFT COLUMN is close on underlying stock
Quote is checked by looking for date and strike for the stock
Quotes for puts and calls are given in two adjacent columns
C. The first thing you must do is determine cost of purchasing one contract (100 shares) which is quoted
price x 100.
D. The second thing is to determine if contract is in the money or out of the money. This depends on whether it is a PUT
or CALL (see page 1)
E.
The profit on a contract is equal to profit or loss LESS cost of the contract or multiple contracts.
EXAMPLE:
You buy 5 puts with a $60 strike at a price of $4.50 per share
In the left column you read the closing price of the stock. $62
In the appropriate column you read the premium for one share
This contract is OUT OF THE MONEY. A PUT IS IN THE MONEY
WHEN PRICE < STRIKE
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If price is unchanged at expiration, you have no profit. The option expires worthless.
Your loss is $4.50 x 500 = $2250. This is the premium you paid.
If stock is worth $55 on date of expiration you MUST EITHER
A. Sell the option or
B. Exercise it
If you exercise it by selling the stock at $60 (the strike) for a $5 GROSS profit of
$2500 LESS YOUR Premium of $2250 for a
NET PROFIT OF $250 for the 5 contracts
OPTION PROBLEMS
1.
2.
3.
4.
Read the question
Diagram it.
Show your work NEATLY
IN TVM problems, show your keystrokes:
P/Y= number of compounding periods / yr
N= years * P/Y
I/Y = stated interest or coupon
PV, FV or PMT
What are you solving for?
4. Think. It this answer logical?
I should not have to search all over the page (or the back) to see your mistake or calculations. I will make every
effort to give partial credit must you must SHOW YOUR WORK.
Many exam problems will not be multiple choice. You should show your work neatly and circle
or underline the answer clearly. The only way to study for TVM, options, bond problems and
currency translation problems, is to do practice problems. Ask questions if
you are unclear on any concept.
APPENDIX
A. LIBRARY REFERENCE SOURCE MATERIALS
My web site
Start your research here:
EDGAR—SEC filings
Yahoo finance---charts and current earnings
NASDAQ.COM
BIG CHARTS--print a 5 year chart on your bank. Check for
any splits or stock dividends since the LAST annual report.
I will provide web sites for any additional projects
The Federal Reserve Bulletin
Published bi-monthly by the Board of Governors of the
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Federal Reserve in Washington. This bulletin provides
macroeconomic data on interest rates, the National Income and
Product Accounts, inflation, and the U.S. budget. Articles deal
with specific issues relating to Monetary Policy. Copies are
located in the reference section of the UMD library.
Lexis - Nexis Database
Computer terminals in reference section of UMD library.
Provides the ability to screen current periodicals for news on a
topic or company.
Value Line Investment Service
Loose leaf binder with financial data arranged by industry
and financial information on individual companies on one side
of a single page. Value line is available in most public libraries
as well as at the main campus library and Embry-Riddle.
Moody’s Books
These books are arranged by industry and are located in the
stacks of the reference section. The Industrials are a large red
book. Bank and Finance is a black book with gold lettering.
Use the most current book. There is also a paperbound
Moody’s Handbook which provides one page of data on the
largest U.S. Corporations.
FINANCIAL FUNCTIONS USING AN EXCEL WORKSHEET
In this course you will learn about financial modeling. Financial modeling using an Excel spreadsheet is fun and it allows
you to be creative. In order to build your model for the term paper, you will need to look up some key financial functions.
You will not need all of these and this is provided for reference.
The following is copied from the Office 97 Excel “Help menu”
Financial functions perform common business calculations, such as determining the payment for a loan, the future value or
net present value of an investment, and the values of bonds or coupons.
Common arguments for the financial functions include:
·
·
·
·
Future value (fv) – the value of the investment or loan after all payments have been made.
Number of periods (nper) – the total number of payments or periods of an investment.
Payment (pmt) – the amount paid periodically to an investment or loan.
·Present value (pv) – the value of an investment or loan at the beginning of the investment period. For example,
the present value of a loan is the principal amount that is borrowed.
Rate (rate) – the interest rate or discount rate for a loan or investment.
·Type (type) – the interval at which payments are made during the payment period, such as at the beginning of a
month or the end of the month.
Which function do you want to read about? NOTE:
GO TO HELP. TYPE FINANCIAL AND THEN
CLICK ON ANY OF THESE FUNCTIONS TO LEARN HOW TO USE THEM.
ACCRINT worksheet function
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ACCRINTM worksheet function
AMORDEGRC worksheet function
AMORLINC worksheet function
COUPDAYBS worksheet function
COUPDAYS worksheet function
COUPDAYSNC worksheet function
COUPNCD worksheet function
COUPNUM worksheet function
COUPPCD worksheet function
CUMIPMT worksheet function
CUMPRINC worksheet function
DB worksheet function
DDB worksheet function
DISC worksheet function
DOLLARDE worksheet function
DOLLARFR worksheet function
DURATION worksheet function
EFFECT worksheet function
FV worksheet function
FVSCHEDULE worksheet function
INTRATE worksheet function
IPMT worksheet function
IRR worksheet function
MDURATION worksheet function
MIRR worksheet function
NOMINAL worksheet function
FINANCIAL FUNCTIONS USING AN EXCEL WORKSHEET CONTD.
NPER worksheet function
NPV worksheet function
ODDFPRICE worksheet function
ODDFYIELD worksheet function
ODDLPRICE worksheet function
ODDLYIELD worksheet function
PMT worksheet function
PPMT worksheet function
PRICE worksheet function
PRICEDISC worksheet function
PRICEMAT worksheet function
PV worksheet function
RATE worksheet function
RECEIVED worksheet function
SLN worksheet function
SYD worksheet function
TBILLEQ worksheet function
TBILLPRICE worksheet function
TBILLYIELD worksheet function
VDB worksheet function
XIRR worksheet function
XNPV worksheet function
YIELD worksheet function
YIELDDISC worksheet function
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YIELDMAT worksheet function
An Excel spreadsheet model can perform any of the functions you can perform on your financial calculator. The
advantage of the model is that complex calculations can be designed in advance and all you need to do is enter the input
variables.
YIELD TO MATURITY
(THIS IS AN EXAMPLE OF INSTRUCTIONS ON ONE FUNCTION)
Returns the yield on a security that pays periodic interest. Use YIELD to calculate bond yield.
If this function is not available, run the Setup program to install the Analysis ToolPak. After you install the Analysis
ToolPak, you must enable it by using the Add-Ins command on the Tools menu.
Syntax:
YIELD(settlement,maturity,rate,pr,redemption,frequency,basis)
Settlement is the security's settlement date. The security settlement date is the date after the issue date when the security
is traded to the buyer. (CORP = 3 BUSINESS DAYS, GOVT = NEXT BUSINESS DAY) SDT ON CALCULATOR
Maturity is the security's maturity date. The maturity date is the date when the security matures or is called.
RDT ON CALCULATOR
Rate is the security's annual coupon rate. CPN ON TIBA2+ FINANCIAL CALCULATOR BOND WORKSHEET
Pr is the security's price per $100 face value. PRI ON CALCULATOR
Redemption is the security's redemption value per $100 face value. (100 AT MATURITY OR VALUE OF CALL)
Frequency is the number of coupon payments per year. For annual payments, frequency = 1; for semiannual, frequency
= 2; for quarterly, frequency = 4.
Basis is the type of day count basis to use.
FINANCIAL FUNCTIONS USING AN EXCEL WORKSHEET --
(yield to maturity)
Basis Day count basis
0 or omitted
US (NASD) 30/360
1
Actual/actual
2
Actual/360
use for Treasuries and Munys
3
Actual/365
use for all U.S. Corporate bonds
4
European 30/360
The settlement date is the date a buyer purchases a coupon, such as a bond. The maturity date is the date when a coupon
expires. For example, suppose a 30-year bond is issued on January 1, 1996, and is purchased by a buyer six months later.
The issue date would be January 1, 1996, the settlement date would be July 1, 1996, and the maturity date would be
January 1, 2026, which is 30 years after the January 1, 1996, issue date.
·
Example
A bond has the following terms:
February 15, 1991, settlement date
November 15, 1999, maturity date
5.75 percent coupon
95.04287 price
$100 redemption value
Frequency is semiannual
Corporate settlement
The bond yield is: YIELD("2/15/91","11/15/99",0.0575,95.04287,100,2,0) equals 0.065 or 6.5 percent
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PRICE EXCEL FUNCTION
Returns the price per $100 face value of a security that pays periodic interest.
If this function is not available, run the Setup program to install the Analysis ToolPak. After you install the Analysis
ToolPak, you must enable it by using the Add-Ins command on the Tools menu.
Syntax: PRICE(settlement,maturity,rate,yld,redemption,frequency,basis)
Settlement is the security's settlement date. The security settlement date is the date after the issue date when the security
is traded to the buyer.
Example
A bond has the following terms:
February 15, 1991, settlement date
November 15, 1999, maturity date
5.75 percent semiannual coupon
6.50 percent yield
$100 redemption value
Frequency is semiannual
Corporate settlement
The bond price (in the 1900 date system) is: PRICE("2/15/91","11/15/99",0.0575,0.065,100,2,0) equals 95.04287
B. THE TIME VALUE OF MONEY: FIN 3403 REVIEW
The saying is “A bird in hand is worth two in the bush.” The value of a dollar received today is worth more than a dollar
received a year from now. Why? Money received now can be invested and earn interest, or it could be consumed.
Investing is trading dollars today for dollars in the future. Borrowing is trading future dollars for dollars today.
Key concepts:
TIME LINE YEARS 0
2
3 YEARS
______________________________________________
Value
$1
$1.10
$1.21
$1.33 10% Compound return
The time line shows that by compounding $1 today it will grow to $1.21 in 2 years and $1.33 in 3 years. This is called
finding future value.
Discounting is the opposite of compounding. Discounting the future value of $1.33 in year 3 to period zero of $1 is called
finding a present value.
The interest rate r is the rate at which a cash flow grows in the future. Compound interest is earning interest on interest.
In the above example, simple interest of 10% would provide an investor with a return of 10 cents per period.
The formula to express the concept of compounding and future value is:
FVn = PV (1 + r)n
FV3 = $1 (1.10)(1.10)(1.10) = $1.33 or
$1(1.10) 3
where n = 3 years
Your financial calculator will help you solve for any of 4 variables: future value (FV), present value (PV), time periods
(n) and the interest rate r. There is another factor to consider in addition. This is the number of compounding periods m.
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The financial calculator requires you to set the number of periods using the key P/Y. You know that daily compounding
will produce a higher future value than annual compounding for example.
We will look at the use of a financial calculator in the next section.
CONVENTION In using a calculator, OUTFLOWS are a negative number and
INFLOWS are positive.
FV CONCEPTS:
1. The higher the interest rate r the higher the future value
2. The longer the time period n the higher the future value
3. The more frequent the compounding m the higher the FV
As noted above, Discounting is the process of taking a Future Value (FV) and placing it in Present Value terms. In
finance this concept is used in a variety of applications. For example:
 The value of an office building is the discounted present value of the rents received for n
years.
 The value of a common stock (using a dividend discount model) is the expected future
dividends paid for n years into the future.
PV =
FVn
(1 + r)n
TVM CONCEPTS CONTD.
We saw above that $1 grew to $1.33 in 3 years at 10% compounded. Conversely, the PV of $1.33 received 3 years from
now is $1
PV CONCEPTS:
1. The higher the interest rate r the lower the present value
2. The longer the time period n the lower the present value
3. The more frequent the compounding m the lower the present value
So far we have dealt with a simple example of single (or lump sum) cash flows
What about multiple cash flows? A constant cash flow over time is called an ANNUITY. This contrasts with a lump sum.
On your calculator, annuity payments are entered using the PMT key. The present value of an annuity (PVA) can be
derived from the following formula:
PVA =
FV
( 1 + r)1
+
FV
(1 + r)2
+
FV
( 1 + r)3
Let us say you receive a paycheck of $500 per week. That is an annuity which pays you a total of $26,000 per year (52
weeks).
The future value of an annuity FVA can be derived using the PMT key on your financial calculator. The PMT is a
recurring cash flow of the same size received over time (n). Let us say you can save $300 per month. At an interest rate r
of 15% per annum compounded, how much money would you have in 30 years? In 25 years?
n = 30 x 12 = 360 months )With the financial calculator, you will learn how to set the calculator for monthly
compounding by setting P/Y to 12. On the calculator you will set P/Y to 12 meaning this is a monthly payment (12 times
per year).
PMT = $300. THIS IS ENTERED AS A NEGATIVE NUMBER -$300
r (I/Y on your calculator) = 15 (note this number is entered with NO decimal)
SOLVE FOR FV: =$ 2,102,946 (This is the FV of $300 per month for 30 years at 15%.
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SOLVE FOR FV WHERE TIME PERIOD IS 25 YEARS (300 months). SET N = 300
FV
= $985,222. (ALMOST A MILLIONAIRE).
Notice that the money more than doubled between 25 and 30 years.
THE “RULE OF 72”
Dividing the number 72 by any interest rate will tell you the approximate .
number of years it will take for a sum to DOUBLE.
Example:
10% (72/10)
=
7.2 YEARS
15% (72/15)
=
4.8 YEARS
20% (72/20)
=
3.6 YEARS
This approximation helps you CHECK simple lump sum future value (FV) problems.
It is important to understand CONCEPTUALLY what the calculator is doing to see if
your answer makes sense. For example, if you invest $10,000 at 10% interest for 7 years
you know from the rule of 72 that the answer should approximate $20,000.
A football player is offered a 3 year contract which will pay $5 today (lump sum) or $ 1 million at the end of year 1, $2
million at the end of year 2, and $3 million at the end of year 3. Assuming an interest rate r of 5%, which offer should he
accept? The PV of the $5 million lump sum is $5 million since it is received today. What is the PV of 3 uneven cash
flows totaling $6 million over 3 years? The answer is $5,357,952.
USING A FINANCIAL CALCULATOR The TI BA II plus
1. STARTING OUT USING YOUR CALCULATOR TO SOLVE TVM PROBLEMS
Please read the TI BAII PLUS MANUAL Ch 1 and pp. 3-2 to 3-9
Please follow these steps each time you use your calculator :
1. Clear all registers using 2nd CPT, 2nd CLEAR TVM and 2nd clear Work keys
2. Check P/Y key. For annual calculations set it for 1 payment per year. For bonds (unless otherwise specified) it is 2/y
since bonds pay semiannually, for bank loans it may typically be set at 12/Y (i.e. one payment per month (the default
setting).
3. How many decimal points do you need? In some calculations you may want 5 digits to the right of the decimal.
ENTER 2ND FORMAT 5 (ENTER) This sets calculator to needed accuracy.
2. TIME VALUE OF MONEY KEYS
These 5 keys are located the third row from the top. FROM LEFT TO RIGHT, THESE KEYS ARE:
YOU CAN ENTER DATA IN 3 OR 4 KEYS IN ANY ORDER AND SOLVE FOR THE REMAINING KEY (the
dependent variable) BY ENTERING CPT AND THAT KEY.
N
N is equal to the number of years times P/Y.
if the years = 5 and P/Y is 2
n=10
I/Y
Annual interest rate
Enter as a whole number (I.E. 10% IS ENTERED AS 10)
PV
Present value
PMT
Payment
This is an annuity payment repeated over N periods
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FV
Future value
Always enter cash outflows as a negative number. For example if you invest a sum of $100 per month as a
PMT, this should be entered as 100 and the minus key in the lower left of calculator followed by pressing PMT
Any of these keys can be the dependent variable. For example, say you want to determine how many years it will take for
you to accumulate $1,000,000 by saving $500 per month at 10% E. growth per annum.
ENTER
P/Y = 12 ENTER
I/Y= 10
PMT= -500 (OUTFLOWS ARE A MINUS NUMBER)
FV = 1000000
ENTER CPT , N
= 345.0922 MONTHS
DIVIDE BY 12
=28.758 YEARS
If you stand to inherit $100,000 in 10 years, what is it worth now (what is the net present value) at a 10% discount rate?
ENTER
P/Y = 1 ENTER
N = 10
I/Y= 10
FV=100000
ENTER CPT, PV
= 35174.82
This means that $100,000 received 10 years from now is worth $35,175 today at 10% I/Y. If the
$35,175 is invested at 10% compounded annually it will be worth $100,000 in 10 years.
USING THE FINANCIAL CALCULATOR CONTD.
3. USING YOUR CALCULATOR IN AN EXAM
In this course we will focus on simple compounding, time value of money calculations, and calculation
of current yield and yield to maturity for a bond. (TEXT ch 8.)
Approximately 80% of this exam will involve TVM problems using your financial
calculator. In BE 353 you will use the 3rd row of keys as well as the bond worksheet.
When solving a TVM problem there are 5 variables (the 3rd row of keys on your
calculator)
N
number of time periods. (P/Y) x (years) . 30 years of monthly pmts: N = 360
P/Y
Payments per year The default setting of your calculator is P/Y = 12. Be sure and
check this setting before entering data. P/Y = 12 is for monthly cash flows.
I/Y
annual interest. Enter as a number with no decimal (10% is entered as 10)
PV
PMT
FV
Present value. This is for LUMP SUMS
CONVENTION: Outflows are entered as a negative number
Payments -- An ANNUITY stream of EVEN cash inflows or outflows.
Future value. This could represent the value of a portfolio for example where
you invested a lump sum (PV entered as an outflow) and/or a series of PMTS
(also entered as outflows).
Be sure and check P/Y. If you are making monthly payments P/Y = 12
4. YOU CAN BE A MILLIONAIRE?
Can you save $300 per month? Assume a return of 15% compounded annually.
Clear registers.
Set P/Y for 12 PRESS 2ND P/Y ENTER 12 (PRESS ENTER)
ENTER -$300 AND PRESS PMT (this is an outflow so it is negative)
ENTER $1000000
PRESS FV
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ENTER 15
PRESS I/Y
(ANNUAL RETURN OF 15%)
SOLVE FOR N
( Cpt key then N)
N = 301.16 MONTHS
25.09 YEARS AND
YOU HAVE $1 MILLION!!!
5. TVM APPLIED TO VALUATION OF BONDS AND STOCK
You have learned to solve TVM problems involving lump payments or future value and annuities. Let us consider a case
where BOTH techniques apply in one problem.
1.
VALUING A CORPORATE BOND
A bond represents two cash flows: a regular payment (semi-annual coupon interest) and
a future lump sum paid at maturity.
2.
TERMINOLOGY
COUPON RATE
% COUPON AND DOLLAR COUPON
Dollar coupon = $1000 x
(% coupon)
2
If coupon is 8%, the bond pays $80 in interest annually (8% x $1000)
SINCE ALL bonds we will study pay interest semiannually
the dollar amount of each coupon is $40 ($80 / 2)
TVM APPLIED TO VALUATION OF BONDS AND STOCK CONTD.
PAR
($1000 – QUOTED IN PAPER AS % OF PAR)
CURRENT YIELD
COUPON/PRICE
YIELD TO MATURITY
BOND RATING (S&P or Moody’s) –measures quality
BOND TRUSTEE
BOND PRICE_________________________INTEREST RATES
^
INVERSE RELATIONSHIP:
As interest rates on bonds of similar type, quality and maturity RISE bond prices FALL
As interest rates on bonds of similar type, quality and maturity FALL bond prices RISE
6. THE BOND WORKSHEET
.
PROBLEM:
ENTER
What is the yield to maturity of a 8.75% bond due in 20 years selling at 105
2nd
BOND
CLR WORK
Enter settlement date (This is the date the bond would be paid for in a trade:
IMPORTANT NOTE: Corporate settlement is 3 business days from trade
date. Settlement on U.S. Treasury issues is next day (trade date + 1)
ENTER SDT (settlement date): Use June 30, 1997
ENTER THIS DATE AS: 6.3097 PRESS ENTER AND DOWN ARROW
CPN: The menu prompts you for coupon in pct 8.75% = 8.75 ENTER
ENTER RDT (redemption date): This is the date the bond matures or is called.
In this problem maturity is 20 years from now (June 30, 2017) = 6.3017 PRESS ENTER
PRESS DOWN ARROW KEY
RV = ENTER PAR (100)
All bonds mature at $1000. Bonds are quoted as
a percent of par. Enter $1000 as 100% or 100.
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ACT
360
2/Y
ACT IS FOR CORP BONDS AND MEANS A 365 DAY YEAR
360 IS USED FOR U.S. TREASURY AND MUNY BONDS
Leave calculator set at semiannual interest pay. This is true of all corporate bonds
we will be studying.
PRI: SKIP OVER YLD AND scroll down to PRICE and enter 105. 105=$105% 0f par or a
dollar price of $1050.
YLD Scroll UP ARROW to YLD and enter CPT
SOLUTION IS 8.23% THIS IS THE YIELD TO MATURITY
BOND AND STOCK VALUATION AND TERMINOLOGY
A bond is a financial instrument with a fixed MATURITY, a stated interest or COUPON rate and a stated par value of
$1000. In this course all corporate bonds will have a $1000 par. Corporate bonds pay interest SEMIANNUALLY (i.e.
P/Y on your calculator should be set to 2 for ALL bond problems.) Bonds mature at par. Bonds are quoted as a percent
of par. A price of 103 means 103% or par or $1030. Corporate Bonds may be CALLED prior to maturity at a stated
premium (REDEMPTION CALL PRICE) to par. An example is a call premium of 3%. This translates to a redemption
call price of $1030.
The value of a bond is the sum of the net present value of all interest coupons (AN ANNUITY), and the PV of the
redemption value (PAR or REDEMPTION CALL PRICE). The coupons and the redemption value are discounted to
present value at the CURRENT RATE OF INTEREST ON BONDS OF SIMILAR TYPE, QUALITY AND
MATURITY.
PROBLEM: You own an A rated bond that matures in 15 years. The coupon rate is 8%.
The interest rate currently on 15 year A rated corporate bonds is 7.5%.
Calculate the bond value.
USE TVM KEYS
1. Set P/Y to 2
2. N=30
3. I/Y =7.5
4. FV = 1000
5. PMT = 40 (Semiannual coupon of $40—8% interest on a
corporate bond is $80).
CPT PV
= 1071.32 (QUOTED AS 107.13)
THIS IS THE THEORETICAL VALUE OF THE BOND.
NOTE THE BOND IS SELLING ABOVE PAR. WHY?
3.
VALUING COMMON STOCK
TERMINOLOGY
E.P.S. (Earnings per share)
D.P.S. (Dividends per share)
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net income/ common shares out
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DIVIDEND YIELD
D..P.S. / PRICE (quoted in WSJ)
P/E
price / E.P.S.
(price / earnings ratio)
(quoted in WSJ)
Common stocks in the U.S. pay dividends QUARTERLY. The dividend per share (DPS) is quoted in the WSJ. Divdends
are always quoted at the ANNUALIZED quarterly rate (1.e. the last qtrly DPS times 4).
One way to value common stocks is to compare its P/E with the P/E of the “market INDICES” SUCH AS THE S&P 500.
Another method is the use of a Dividend Discount Model which will be discussed in class.
MACROECONOMIC REVIEW
THE TWIN DEFICITS: FISCAL AND BALANCE OF PAYMENTS
A.
MACROECONOMIC EQUILIBRIUM
REVIEW:
C + I + G + NX = GDP
C = CONSUMPTION
I = INVESTMENT
G = GOVERNMENT SPENDING (Federal, State, Local)
NX = NET EXPORTS
S = I
S = SAVINGS
As the savings rate increases, I increases.
C is a high percentage of GDP. As S increases, C has a tendency to
decrease. Put another way, with personal disposable income growing
slowly, consumers are saving for retirement and this leaves less money
available for current consumption.
What industries are impacted by this trend (positively and negatively)?
If the Federal Government decreases overall spending, this acts as “fiscal drag.”
Deficit spending acts as stimulus. Spending on capital goods (such as military
hardware or an interstate highway) has a greater multiplier effect on the economy
than transfer payments.
BALANCE OF PAYMENT DEFICIT
CURRENT ACCOUNT
A. TRADE
(EXPORTS +
IMPORTS -)
B. SERVICES (EXPORTS + IMPORTS -)
C. MILITARY TRADE (included in B)
D. INCOME ON OVERSEAS INVESTMENTS
(RECEIPTS +
PAYMENTS -)
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E. UNILATERAL TRANSFERS (foreign aid etc)
CAPITAL ACCOUNT
A. U.S. OVERSEAS INVESTMENTS (public and private)
B. OTHER
When the media speaks of balance of trade deficits, they are referring to the
CURRENT account.
Think of a Robinson Crusoe Economy:
USA
VS
REST OF WORLD
The economic term for this is “Mercantilism”
THE TWIN DEFICITS contd.
FISCAL DEFICIT
Review questions:
1.
2.
3.
What is the macroeconomic effect of fiscal deficits?
What is “crowding out?” see pp. 611-14
What is role of Federal Agencies such as Fannie Mae (FNMA) or FHA, &
GNMA.
Federal spending is controlled by a budget. The Federal budget makes no distinction
between CAPITAL ITEMS (like an aircraft carrier or an interstate highway) and
CURRENT EXPENSES like Government pensions.
The Fiscal Deficit is simply REVENUES Income tax (indiv. And corporate)
Tariffs and excise taxes
Estate and gift taxes
Sales of assets
LESS
EXPENSES Transfer payments
Military spending
All other
CURRENT ISSUES
A. INTEREST RATES AND FINANCIAL INSTRUMENTS
1.
2.
Using the current Wall Street Journal, determine TODAY’S level of interest rates for each of the column headings.
Are rates higher or lower than in the recent past? Why? Prepare a table listing yields from the most recent issue of the
Wall Street Journal for Treasury bills, notes and bonds from 90 days to 30 years. Compare this with yields 10 and 20
years ago (use taxt for older yield data). What is the significance of this data?
Visit a local stock broker and select THREE muny bonds: A General Obligation or GO (use a City of Detroit GO) a
revenue bond (see if you can obtain a Detroit Airport Bond), and an Industrial Development Revenue (IDR) bond.
Compute the current current yield, yield to maturity and tax equivalent yield (assuming a 36% personal tax bracket).
Compare State of Michigan bonds with and City of Detroit Gos in the same maturity range. Explain the difference.
See instructor for data sources and how to compute tax eq. Yield. Go to a brokerage firm and get an offering
memorandum on a recent municipal bond issue. Be prepared to discuss this document with the class.
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3.
4.
In the Sunday Free Press, look in the real estate section and determine the current rates for ARMs, 15 year fixed rate
mortgages and 30 year mortgages (20% down payment). Prepare a table comparing rates among large commercial
banks, thrifts and other independent mortgage brokers. How many “points” must be paid? What are points? Visit a
local realtor and ask then to give you typical closing costs in a $100,000 home purchase.
Prepare a handout and overhead slide showing the following rates from at least 3 different depository
institutions:
 Passbook savings rate
Interest rate for a new car loan
 2 year CD yield
ARM and 30 year mortgage
 Credit card interest rate
Explain why these rates vary. Explain the meaning of the “prime” rate for banks.
5.
Compare interest rates in the United States and 4 other countries including at least 2 in Europe and 1 each in South
America or the Caribbean and the Far East. Check for recent articles dealing with the wide variance in rates in places
like Singapore, Malaysia, Thailand and Hong Kong and summarize. Comment on the
implications of the return of Hong Kong to the Chinese Government.
A. INTEREST RATES AND FINANCIAL INSTRUMENTS contd.
6. Using Moody’s and Standard and Poor books in the library, prepare a presentation on how rating agencies rate
corporate bonds using the scale of AAA to C. What constitutes an “investment grade” bond. How do the rating
agencies make this rating decision. Explain the meaning of so called “junk bonds.” Research the era of Mike Milken
and Drexel Burnham and Lambert in the 1980s where Junk Bonds were used to finance a wave of corporate buyouts
and mergers.
B. DEFICITS AND TRADE
7.
Discuss the impact on tariffs and free trade agreements (NAFTA in particular) on the U.S. balance of trade current
account and the U.S. banking system.
8.
What is the effect of differing rates of inflation between two countries on the merchandise trade deficit? Use oil as an
example. What is the impact of “Petrodollars” on U.S. banks?
9.
Explain the general terms of the “Balanced Budget” agreement recently negotiated by the U.S. Congress. What
does it mean to an individual American and to the cumulative national debt?
C. MONETARY POLICY – CURRENT EVENTS
As we approach the New Millenium there have been articles in the Wall Street Journal implying that the business cycle
has been “controlled” or is “dead.” The financial markets watch with anticipation each Fed Board and Open Market
Committee meeting. The U.S. economy is like a large ocean steamship. It takes the QE 2 about a mile from the time the
Captain reverses engines at high speed for the skip to come to a complete stop. Our economy responds to economic
stimuli in a delayed fashion also. Changes in interest rate policy by the Fed may not show up in GDP, employment or
other economic indicators for 6-9 months. Therefore, like a good coach, the Fed attempts to anticipate changes in
economic activity and inflation by examining leading economic indicators. This process involves much research by Fed
economists in Washington and in the regional banks. Some journalists would have us believe that happy days are here
again and that we are in a “New Era” of low inflation and moderate economic growth. What do you think? If the Fed is
to be measured by the level of prices only, the current Fed chairman deserves considerable credit. However, some
lingering questions remain:
1.
2.
In the glory days of the British Empire, prices at home were kept low through importation of cheap goods and raw
materials from the Commonwealth. This economic structure was enforced by the British Navy which for 200 years
was the dominant military force on the High Seas. The U.S. has assumed the role of world “Policeman” in the Post
WWII world. The Gulf War showed the impact of speaking softly and carrying a “Big Stick” as Teddy Roosevelt
was fond of saying. What are the possible consequences of this?
The Fed was created in 1914 at the beginning of WWI. Approximately 15 years the stock market crash of 1929
plunged the economy into a Great Depression. What are the odds that a stock market collapse could trigger a similar
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3.
economic meltdown now? What similiarities and differences exist today between today’s financial markets and those
of 1929?
To paraphrase Mark Twain, the rumors of the death of the Business Cycle are greatly exaggerated. The business
cycle in the U.S. was historically affected by capacity utilization rates. As “plant” capacity in an industrial sense
approached 85%, prices and wages rose. This tended to cause demand to fall particularly for capital goods such as
automobiles. Derived Demand sectors tended to overwhelm the rest of the economy as consumer confidence fell due
to rising unemployment in these industries. Today, in the “Post Industrial Society,” capacity cannot be measured in
the traditional industrial sense for the huge service sector. Moreover, U.S. corporations have moved considerable
plant capacity overseas (where labor rates are cheaper) and have “outsourced” many components and
CURRENT EVENTS contd.
parts making it difficult to determine true capacity levels. This has created a “Global Village” effect where
dislocations in one major economy have ripple effects through all major economies and exchanges. What is the
impact of this on traditional business cycle theory? How can the Fed “manage” this based on U.S. based economic
statistics when we are part of a New World Order?
1. Inflation is Enemy Number One as far as the Fed in concerned. The Fed views inflation as a hidden “tax” that
reduces disposable personal income for individuals and businesses. The era of the late 1970s is a painful memory.
This period of rapidly rising inflation was caused largely by two events: The Vietnam War and the policy of “Guns
and Butter” which means deficit spending rose to accommodate a war and rising social program spending, and the
Arab Oil Embargos which had a dramatic impact on all U.S. households and the Current Account Deficit. We went
to war in the Persian Gulf, some observers say, to preserve our lifeblood of cheap crude oil. What do you think will
happen if oil prices rise sharply possibly due to terrorist sabotage? How will the Fed respond?
2. The famous saying “Those who fail to heed the lessons of history are doomed to repeat it” is certainly true with
respect to monetary policy. Two Twentieth Century examples of disastrous economic policies having severe political
consequences are Post WWI Germany which led to the rise of Hitler and the Era of Juan and Eva Peron in Argentina
which is now highlighted in the movie “Evita.” In Germany it took a wheelbarrow of Marks to buy a loaf of bread.
To some extent this phenomenon has been quietly played out in Russia as the collapse of Communism and fixed
prices caused the value of the Ruble to plummet. This has left millions of pensioners from the old Soviet system
destitute. What is the political risk in this? What can we do about it?
6. The term “Crash” applied to the Stock Market was last applied in 1987. This was a relatively short lived event
compared to the 1929 “Crash” which really lasted until 1932 and triggered the Great Depression. History indicates
that market crashes or “Panics” as they were called in the 19th. Century are caused by unforseen events. We have
mentioned some possible “triggers” that could cause a panic. Here (in no particular order) are a few more:
 North Korea invades Sough Korea because of widespread starvation.
 A terrorist group detonates a nuclear device assembled from old Soviet stockpiles or from a nuclear
power reactor in a major financial center. A similar result could occur from a nuclear accident at a
power plant near a major city..
 There is a coup in Saudi Arabia led by a militant faction similar to the fall of the Shah in Iran. This
results in a major increase in crude oil prices.
 China clamps down on Hong Kong causing economic ripples through all of the Pacific Rim.
On a less dramatic note, stock markets are supported by earnings per share (E.P.S.). Earnings growth has been
above trend line due to a number of conscious policies:
 Common share repurchase. Since E.P.S. equals net income divided by common shares outstanding,
a reduction in share count grows E.P.S. faster than net income. This can not be sustained
indefinitely.
 Use of financial leverage (debt). There is a modest rebirth in the philosophy of the Eighties where
so called “junk bonds” were used to finance leveraged buyouts.
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
Downsizing. Everybody does it now, even the Japanese where “lifetime” employment was
considered almost a sacred right. In the U.S., downsizing has created an economic underclass of
underemployed people. Loyalty to a company has dropped as a result and a cult of “Economic
Darwinism” is rising. This can lead to big swings in consumer confidence. Strong confidence is
critical to a health stock and bond market.
 Dramatic increases in use of part time workers. This has benefited companies like Manpower and
Kelly Services. The problem is that workers frequently do not have benefits in these part time jobs
If you were Fed Chairman, you would have a task force developing plans to deal with each of these scenarios. What
would your marching orders be in developing contingency plans to these possible events?
CAREER OPPORTUNITIES IN BANKING AND FINANCE
For those of you who are interested, I will be happy to discuss career opportunities with you during
office hours.
You should consider doing one or more internships with a company during your course of study of
UMD. This will give you a “hands on” opportunity to investigate career options. Our internships in
the School of Management are designed to provide you with solid practical experience combined with
your course of study. See Charlotte Whitney in the internship office for more information.
I have spent over 30 years as a financial manager. I have been a bank trust officer, served as CEO of
a money management company, managed a growth “Go-Go” mutual fund, and been the Director of
Research of two regional brokerage firms. In my personal experience, the most exciting aspects of
this field are:




It is dynamic. Every day is different.
You are pitting your skills against the best brains in the World. Finance is
a highly paid profession. As such, it tends to attract highly qualified and
motivated people such as yourself.
Finance is the heart of any enterprise. Can you imagine any business,
governmental entity, or not-for-profit group without a cash or capital
budget for example?
You will use concepts in this course in every day life. The financial
calculator will help you evaluate the APR on a mortgage, determine the
true cost of an auto lease, and compute how much you need to save to have
a comfortable retirement.
Here are some areas for you to consider in your interviewing. Even if you are currently employed, it
is suggested that you take advantage of the UMD placement office to gain experience in interviewing,
and to learn more about career options. An internship is an option available to you to see a business
or industry from the inside and see if it is for you.
A. CORPORATE TREASURY
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Large corporations hire financial analysts and accountants to staff their large treasury
functions which engage in credit analysis, cash management, capital budgeting, and
risk management activities. This is an excellent place to gain experience. Larger
corporations tend to use more sophisticated analytical techniques. Many students
start there or in public accounting and then move to a CFO role in a larger enterprise.
You will probably have more campus interview opportunities in this area than in any
other. Take advantage of it.
:
CAREER OPPORTUNITIES IN FINANCE CONTD.
B. COMMERCIAL BANKING
Commercial banks are the Department Stores of finance. Training programs for managers cover
many departments including
Credit
Commercial lending
Trust and investment management
Leasing
Mortgage lending and administration
Branch administration
 Banking is consolidating. This creates opportunity. Banks are entering
 Investment banking (securities underwriting), stock brokerage,
insurance and financial planning. There are about 13,000 banks in
the U.S. today. Many of the larger banks are overseas.
B.
INSURANCE
There are 3 primary types of insurers that we have studied. They
are:
 Life insurers including credit life
 Fire and Casualty (also called property and casualty)
 Multi-line (a combination of the two above forms)
Insurance companies are state regulated and may be of mutual or
stock form. Life companies tend to invest in longer term instruments like real
estate and stocks. They tend to do many “private placements” in
which an entire corporate bond or preferred issue is placed.
P&C companies are focused on shorter term instruments because
they are impacted by unforseen events like a flood or fire. They still
do invest in common stock and have large portfolios. P&C
companies make use of derivatives for hedging.
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Career opportunities for finance students include financial planning, portfolio
management, actuarial analysis, and sales management. Insurance companies
tend to be stable and have excellent benefits.
C.
INVESTMENT BROKERAGE AND INVESTMENT BANKING
These firms are usually categorized two ways:
 Wire houses. These are large national firms like Merrill Lynch.
 Regionals like A. G. Edwards.
The larger wire houses are typically located in New York.
CAREER OPPORTUNITIES IN FINANCE CONTD.
Commercial banks are attempting to enter the investment banking industry
with the demise of Glass-Steagall restrictions in the U.S.
Investment banking is the activity associated with raising new funds in the
form of an initial public offering (IPO) or secondary. Investment banking
tends to be cyclical since activity varies with the level of the stock and bond
markets. Merger and Acquisition (M&A activity) tends to be the bread and
butter revenue source when deal flow is light.
Research is another activity for regionals and wire houses. Analysts tend to
specialize in one or two industries and publish reports with specific
recommendations. An MBA is generally considered necessary to land a
corporate finance or research job.
D.
MONEY MANAGEMENT
Money managers handle individual portfolios and employee benefit
funds for corporations, churches, and other organizations. These organizations
tend to hire experienced traders, analysts, and bank
trust officers. An exception is mutual funds which will hire analysts from top
business schools like U of M. Again an MBA is necessary.
E.
PUBLIC ACCOUNTING
School of management students who take a concentration in accounting are
prepared to sit for the CPA exam upon graduation. Many go to work for Big 6 public accounting
firms. This experience can serve as a springboard for a career as a chief financial officer with a
business, non-profit institution, or in public service. For example, for many years the FBI only hired
CPAs and lawyers.
F.
OTHER (Thrifts, credit unions, non-profit organizations, government).
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Governmental entities need finance managers. So do many church
organizations, private pension funds, unions, casinos, airports,
sports teams, hotels and resorts, etc. Be creative. Use your
contacts. As in any profession, specialization usually is the key to higher pay.
PREPARING YOUR RESUME
I will be happy to review your resume. Here are some rules:
1. State your career objective at the top of the resume. This statement can be
modified to fit your interview on your PC but it must have one
characteristic: it should state what you can contribute to the company. Do
not say you want to learn to be a financial manager.
2. Print your resume on quality bond paper with matching envelope.
3. State skills including expertise in MS Word, Excel, Powerpoint, and other
software. This will help set you apart.
4. Do not attach references to the resume but line up references before you
interview.
5. If you plan to mail resumes, DO NOT send them to Human Resources. Try
and hand deliver one to a contact in senior management. Network and use
family contacts. Failing that, try sending the resume to the CEO via FedEx.
Companies receive hundreds of resumes each day. Personal contact is the
best way to get noticed.
6. If you place a resume on a web site or E-Mail it, be sure you conform will
all format requirements (usually no bolding or underlying).
INTERVIEWING TIPS
1. Use the UCF recruiting office.
2. Do a financial statement analysis on a corporation before you go to the
interview and read the annual report. Prepare a list of questions. Prepared
candidates will get invited for a second interview.
3. Dress professionally.
4. Be sure and send a thank you letter after every interview and after you
accept a position. Courtesy goes a long way. You will probably want to
change jobs sometime in your career so don’t burn any bridges.
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5. Do a few “trial” interviews before you interview with your top choice.
Experience makes you more relaxed.
I will be happy to provide a reference for students with a grade of “B’ or better.
I will help all students with your resume.
You are strongly encouraged to take advantage of internship opportunities.
BUSINESS WRITING CONCEPTS
Good writing skills are essential for success. Business writing is different from the kind of writing
you have done at the University. Key differences are:
 Business writing summarizes conclusions up front .
 In writing a business report, first outline the points you wish to make and then make liberal use of
subheadings and bullet points to make the paper or memo easy to read.
 Brevity is important. As CEO, I required all memos coming across my desk to me 1 page
maximum. Crystallizing your thoughts in a cogent agrument is a key skill. In college, you
learned that longer is better. Thick term papers were better than short ones. This is not true in
business and is not true in take home exams in this course. Write short sentences filled with facts
and data, NOT long paragraphs.
 Watch spelling and grammar. Write in MS word and save report on a floppy. Use spell checker.
 Journalism students learn that the lead paragraph of a story must cover who, what, when, where,
why and how. Writers spend hours polishing the first sentence. A memo or business paper
should state objectives in the first paragraph. In an essay exam, you should be careful to answer
the question(s).
 A bibliography is usually appended but footnotes are abbreviated.
 Place data or charts in an appendix.
WRITING AN ESSAY EXAM IN THIS COURSE
In this course you can expect one or more take home essay exams. My experience is that many
students have never encountered an open ended essay exam before. Many business school courses
rely on machine scored multiple choice questions. In the “real” world, your ability to survive and get
promoted is dependent on your ability to communicate and persuade.
Here are some thoughts to help you score well on an essay exam:
1.
2.
Read the question carefully. Begin by outlining possible topics to write about. After outlining,
go back and check to be sure you fully answered the question and did not go off on a tangent.
Research the topic in the literature and the internet.
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3.
4.
5.
6.
7.
Develop data supporting your conclusions. You may wish to place this in the appendix in chart
or table form.
Keep answer within specified limits. All answers are to be in this type font (Times Roman 12)
and are to be single spaced. This is standard business format.
Number questions so it is clear what you are answering. If the question has multiple parts, be
sure and indicate each part as A, B, C etc.
Exams are to be individual effort. I will check to be sure that papers do not use similar source
material and quotes (within reason of course)
Type a cover page. Place your name, course, title and date on cover sheet. Do not place the
paper in a binder. Staple it in upper right corner only. Make a floppy disk and hard copy for your
records.
THE ASSOCIATION OF INVESTMENT MANAGEMENT
AND RESEARCH (AIMR)
THE CHARTERED FINANCIAL ANALYST-CFA
AIMR is a nonprofit professional society for practitioners within the investment management profession.
Members include securities analysts, portfolio managers, strategists, consultants, investment counsellors and
academics.
AIMR was founded in 1990 through the merger of the Financial Analyst Federation (FAF) and the Institute of
Chartered Financial Analysts. AIMR currently represents investment professionals in 69 countries. This past
year, over 50,000 candidates sat for one of three parts of the CFA examination. About a third of these
candidates were outside North America.
AIMR is headquartered in Charlottesville, Virginia and publishes many professional publications including
the Financial Analyst’s Journal. It also sponsors conferences and seminars around the world. There are
constituent local societies in over 105 cities worldwide. Local chapters in Florida are in Orlando, Miami,
Tampa Bay and Jacksonville.
I received my CFA designation in 1971 and have been active in the society since 1966. I am involved in
grading the CFA exams. I will be most happy to discuss this professional association with anyone. If you are
contemplating a career in the investment field, you should consider looking into the CFA. The CFA consists
of 3 examinations spaced over 3 years. Each exam is 6 hours in duration. The curriculum is rigorous and
consists of advanced reading in accounting, financial and industry analysis, portfolio management, regulation
and ethics.
My experience as Director of Research for a major brokerage firm is that CFA charterholders earn 10-50%
more than their contemporaries without the designation.
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THE JENNIFER L. DIGGLE MEMORIAL SCHOLARSHIP
IN MEMORY OF JENNIFER L. DIGGLE
BELOVED DAUGHTER
8-7-76 TO 3-6-99
Our daughter Jenny (age 22) was killed in a auto accident during Spring break in a case of vehicular
homicide. Jenny received her degree Posthumously in June 1999. This scholarship was funded in the
Summer of 1999. Part of the funds for this scholarship came from students and faculty at UCF who
contributed generously.
Two scholarships annually will be awarded each semester to a student at the Brevard or Daytona
campus of UCF.
Requirements include:
1. A cumulative GPA of at least 3.0.
2. Undergraduate student taking at least 9 hours per semester
The scholarship will be awarded annually and is renewable each semester if performance is good.
If interested, see me during office hours.
Prof. Ray Diggle
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