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3.) Explain why banks, which would seem to have a comparative advantage in gathering information, have not eliminated the need for the money markets. What are three characteristics of money market securities? Do money market rates usually move together over time? Why or why not? Why would an investor use money market securities instead of putting their money in the stock market, bond market, or a bank? A borrower?

4.) How have mortgages changed over the last 200 years? Why has online lending become more popular over the last decade, and what are the main advantages and disadvantages? Why do banks typically sell mortgages to other investors? How do banks profit off selling loans if they are immediately sold to another investor? Explain why mortgages are bundled before they are sold to investors.

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Nelly Stracke
Nelly StrackeLv2
28 Sep 2019

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How have mortgages changed over the last 200 years? Why has online lending become more popular over the last decade, and what are the main advantages and disadvantages? Why do banks typically sell mortgages to other investors? How do banks profit off selling loans if they are immediately sold to another investor? Explain why mortgages are bundled before they are sold to investors.

Explain why banks, which would seem to have a comparative advantage in gathering information, have not eliminated the need for the money markets. What are three characteristics of money market securities? Do money market rates usually move together over time? Why or why not? Why would an investor use money market securities instead of putting their money in the stock market, bond market, or a bank? A borrower?

Position A: Financial Institutions' role as specialists in risk measurement and management is reduced.

Position B: Financial Institutions' role as specialists in risk measurement and management is increased.

Required:

Read the “background” below. After reading, select the position you agree with and write a position paragraph supporting either Position A or Position B.

Background: A major event that changed and reshaped the financial services industry was the financial crisis of the late 2000s. As Financial Institutions adjusted to regulatory changes brought about in the 1980s and 1990s, one result was a dramatic increase in systemic risk of the financial system, caused in large part by a shift in the banking model from that of “originate and hold” to “originate to distribute.” In the traditional model, banks take short-term deposits and other sources of funds and use them to fund longer term loans to businesses and consumers. Banks typically hold these loans to maturity, and thus have an incentive to screen and monitor borrower activities even after a loan is made. However, the traditional banking model exposes the institution to potential liquidity, interest rate, and credit risk. In attempts to avoid these risk exposures and generate improved return-risk trade-offs, banks shifted to an underwriting model in which they originated or warehoused loans, and then quickly sold them. Indeed, most large banks organized as financial services holding companies to facilitate these new activities. More recently activities of shadow banks, nonfinancial service firms that perform banking services, have facilitated the change from the originate-and-hold model of commercial banking to the originate-and-distribute banking model. In the shadow banking system, savers place their funds with money market mutuals and similar funds, which invest these funds in the liabilities of other shadow banks. Like the traditional banking system, the shadow banking system intermediates the flow of funds between net savers and borrowers. However, instead of the bank serving as the middleman, it is the non-bank financial service firm, or shadow bank, that intermediates. Further, unlike the traditional banking system where the complete credit intermediation is performed by a single bank, in the shadow banking system, it is performed through a series of steps involving many non-bank financial service firms. These innovations remove risk from the balance sheet of financial institutions and shift risk off the balance sheet and to other parts of the financial system. Thus, the financial institutions, acting as underwriters, are not exposed to the credit, liquidity, and interest rate risks of traditional banking.

In your own words, explain what is meant by business and financial risk. Suppose Firm A has greater business risk than Firm B. Is it true that Firm A also has a higher cost of equity capital? Why or Why not? Explain.

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