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Lecture Financial markets and institutions (4/e) – Chapter 21

In this chapter we examine various types of term debt as well as lease financing. After studying chapter 21, you should be able to: Describe various types of term loans and discuss the costs and benefits of each; explain the nature and the content of loan agreements, including protective (restrictive) covenants; discuss the sources and types of equipment financing; understand and explain lease financing in its various forms. | 8- McGraw-Hill/Irwin Chapter Twenty-One Managing Liquidity Risk on the Balance Sheet 21- McGraw-Hill/Irwin Liquidity Risk Management Unlike other risks, liquidity risk is a normal aspect of the everyday management of financial institutions (FIs) At the extreme, liquidity risk can lead to insolvency Some FIs are more exposed to liquidity risk than others depository institutions (DIs) are highly exposed mutual funds, pension funds, and property-casualty insurers have relatively low liquidity risk 21- McGraw-Hill/Irwin Liquidity Risk Management One type of liquidity risk arises when an FI’s liability holders seek to withdraw their financial claims FIs must meet the withdrawals with stored or borrowed funds alternately, FIs may have to sell assets to generate cash, which can be costly if assets can only be sold at fire-sale prices A second type of liquidity risk arises when commitments made by the FI and recorded off-the-balance-sheet are exercised by the commitment holder unexpected loan demand can occur when off-balance-sheet loan commitments are drawn down suddenly and in large volumes FIs are contractually obliged to supply funds through loan commitments immediately should they be drawn down 21- McGraw-Hill/Irwin Liquidity Risk and Depository Institutions DIs’ balance sheets typically have large amounts of short-term liabilities such as deposits and other transaction accounts that must be paid out immediately if demanded by depositors large amounts of relatively illiquid long-term assets such as commercial loans and mortgages DIs know that normally only a small portion of demand deposits will be withdrawn on any given day most demand deposits act as core deposits—i.e., they are a stable and long-term funding source Deposit withdrawals are normally offset by the inflow of new deposits 21- McGraw-Hill/Irwin Liquidity Risk and Depository Institutions DI managers monitor net deposit drains—i.e., the amount by which cash withdrawals . | 8- McGraw-Hill/Irwin Chapter Twenty-One Managing Liquidity Risk on the Balance Sheet 21- McGraw-Hill/Irwin Liquidity Risk Management Unlike other risks, liquidity risk is a normal aspect of the everyday management of financial institutions (FIs) At the extreme, liquidity risk can lead to insolvency Some FIs are more exposed to liquidity risk than others depository institutions (DIs) are highly exposed mutual funds, pension funds, and property-casualty insurers have relatively low liquidity risk 21- McGraw-Hill/Irwin Liquidity Risk Management One type of liquidity risk arises when an FI’s liability holders seek to withdraw their financial claims FIs must meet the withdrawals with stored or borrowed funds alternately, FIs may have to sell assets to generate cash, which can be costly if assets can only be sold at fire-sale prices A second type of liquidity risk arises when commitments made by the FI and recorded off-the-balance-sheet are exercised by the commitment .