Pricing and Markets

1
Pricing and Markets

• Teams 9 10
• Compiled Presented by
• Gerry Fornwald, Kylie Stannard, Karen Dostal,
  Eric Oxley, Siri Heese, Mike Burke, Art McGill,
  and Chia Liek-Kuen

2
Pricing

• To fix or establish an amount, asked for or
  given, in exchange for something else.
• Focus on pricing implications of bank deposits,
  loans, and insurance.

3
Pricing and Banks

• Interest rates on deposits must be high enough to
  attract customers.
• Intense competition between banks.
• FDIC insurance guarantees deposits will be
  honored.
• Premiums affect profit margins on deposits
• Banks must offer lower rates, or lose profit.

4
Pricing and Loans

• Many banks use base-rate loan pricing to
  determine the price of a loan.
• Individual customer loan rate
• r BRDRTM
• r individual customer loan rate
• BR base rate
• DR adjustment for default risk
• TM adjustment for term to maturity

5
Pricing and Loans

• Banks analyze five Cs of credit to determine the
  price of a loan
• Character (willingness to pay)
• Capacity (cash flow)
• Collateral (security)
• Capital (wealth)
• Conditions (economic conditions)

6
Character

• Borrowers integrity, credit history, and past
  business relationship.
• The better these are, the lower the rate.

7
Capacity

• Borrowers projected income
• from income statements or cash flow from job
• Higher capacity leads to lower rates

8
Collateral

• Assets of a borrower to secure a loan
• seized and liquidated by bank in case of default
• The more collateral, the lower the rates

9
Capital

• Borrowers residual wealth from balance sheet
• stock
• land ownership, etc.
• More capital makes the borrower look more
  appealing
• lower rates

10
Conditions

• Economic conditions at the time of loan
• Borrowers vulnerability to economic downturn
  affects rates
• less vulnerability means lower rates

11
Credit Rating

• Once five Cs are analyzed, customers assigned
  credit rating
• Example of bank credit ratings default risk
  premium
• rating 1 prime rate customers
• rating 2 10 to 50 basis points
• rating 3 50 to 100 basis points
• rating 4 100 to 200 basis points
• rating 5 reject credit

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Pricing and Insurance

• Goal of insurer to charge enough to cover
  claims, administrative expenses, and still earn a
  profit.
• Intense competition and strict regulations.
• Extensive statistical analysis required to
  determine premiums.
• Interest rates affect price of premiums.

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Factors in Determining Insurance Premiums

• Car Insurance
• Age - older the better
• Gender - females have lower premiums
• Past driving record
• Life Insurance
• Age - younger means lower
• Gender - female means lower
• Smoking status - biggest factor in premiums

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Premium per Month on Life Insurance for Men and
Women

• Source www.123equotes.com

15
Types of Bond Markets

• U.S. Government Bond Market
• U.S. Government Agency Bond Market
• Corporate Bond Market
• Municipal Bond Market
• International Bond Market

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Bond Break-up

• U.S. Government Bond Market
• U.S. Government Agency Bond Market
• Corporate Bond Market
• Municipal Bond Market
• International Bond Market

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United States Government Bond Market

• Larger trading volume than NYSE
• Over-the-Counter (OTC) trading setup
• 40 dealers make a market, buyers are low-risk
  investorsmultilateral market
• If interest rates increase, the bonds value
  decreases

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Corporate Bond Market

• Primarily over-the-counter
• Owned and traded by large financial institutions
  (life insurance companies, mutual funds, pension
  funds)
• Large blocks of securities are most common sale
• Since any given trade is so large, theres
  actually a small percentage of trades on exchanges

19
Corporate Bond Purchasers
20
Municipal Bond Market

• Local Governments
• State Governments
• Default Risk
• Tax-exempt

21
International Bond Market

• International Bonds are bonds sold outside the
  borrowers country
• Foreign Bonds are bonds with a foreign borrower,
  denominated in the currency of the country that
  sold the bond
• Euro Bonds are bonds issued in one country, but
  denominated in the currency of another

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Advantages of International Bond Markets

• Few disclosure requirements which lowers the cost
  of the trades
• Issued in Bearer form so they are not usually
  registered, ideal for high profile investors who
  wish to remain anonymous
• Most governments dont withhold taxes on interest
  payments
• Large number of U.S. firms in this market

23
Generalities of all Bond Markets

• Political Economic Developments affect all bond
  markets
• As general interest rates decrease, there is an
  increase in investing in alternative markets like
  stock exchanges
• As general interest rates increase, there is an
  increase in investing in bond markets

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The stock market

• Primary market
• initial public offering(IPO) Price offering for
  the market when the company new issues of
  securities
• Secondary market
• trading of the security after primary offering
• price of the stock will determine investors
  buying or selling of securities

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The stock

• Common stock
• Dividends are dependent on the value of the stock

• Preferred stock
• Fixed dividends payment

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The International Stock Market

• The most influential stock markets are
• New York Stock Exchange (U.S)
• Tokyo Stock Exchange (Japan)
• RTS Stock Exchange (Russia)
• London Stock Exchange (England)
• Luxembourg Stock Exchange

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International Stock Market, cont.

• The worlds largest stock market
• New York Stock Exchange (NYSE)
• The worlds smallest stock market
• Fiji Stock Exchange
• The worlds oldest stock market
• London Stock Exchange
• The worlds newest stock market
• Vietnam Stock Exchange

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Market Globalization

• Globalization--the integration of financial
  markets throughout the world into an
  international financial market.
• Factors that have led to the integration of
  global financial markets are
• (1) deregulation or liberalization of markets and
  the activities of market participants in key
  financial centers of the world.
• (2) technological advances for monitoring world
  markets, executing orders, and analyzing
  financial opportunities and
• (3) increase institutionalization of financial
  markets.

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Market Globalization
1980s -24 hour market for US government
securities
1960s -worldwide branching systems began -U.S.
securities firms began to go abroad - Eurobond
market, expansion in Asia
1990s -Internet boom -online investing in
securities in worldwide markets
1970s -24 hour markets -international bank and
brokerage offices throughout world
2000s -real time information -more or less govt
reg??? -single world currency??? -?????????????
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Market Globalization

• Governments deregulate so financial enterprises
  can compete effectively around the world.
• Technology advances increases integration and
  efficiency
• links the world
• orders are executed in seconds
• transmission of real-time info.
• Includes advancements in telecommunication and
  computers.

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Motivation for Using Foreign Markets Euromarkets

• 1st Inability to raise substantial amount of
  funds.
• Forced to finance in foreign markets.
• Domestic market not fully developed, therefore
  cannot satisfy demand.
• Developing countries use for obtaining lower cost
  of funding.
• Starting to diminish because of integration of
  markets throughout the world.
• Diversification of funding so as to reduce
  reliance on domestic investors.
• Example

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Classification of Global Financial Markets
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A New Way to Profit

• Now Featuring
• Correspondent Banking
• Trust Operations
• Investment Products
• Insurance Products

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Correspondent Banking

• What it is
• as a way to enhance fees revenue banks offer
  their services to other banks and financial
  institutions
• Services included
• check clearing, collection, purchase of
  securities, foreign currency exchange, making of
  large loans, etc.
• a small rural bank may want to have a larger bank
  clear checks because they lack the personnel to
  do so in a timely manner and using a
  correspondent relationship is more cost effective

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Trust Operations

• What it is
• this is where a bank acts as a fiduciary for an
  individual, business, or someones estate, this
  mainly deals with holding and managing assets for
  the benefit of a third party
• Major Accounts
• Individual Accounts
• the bank will see that the terms of an
  individuals will is carried out, claims are
  settled, and beneficiaries get what is theirs
• Pension Accounts
• managing assets for the future pensioners benefit

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Trust Operations

• Other Services
• rendering services as getting dividend payment to
  shareholders or coupon payments to bondholders on
  behalf of the corporation

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Investment Insurance Products

• Investment Products
• Brokerage Services
• executing trades through affiliate institutions
  for a fee
• Mutual Funds
• in 1998 banks were managing 17 of all mutual
  fund assets in the United States
• Insurance Products
• Annuities
• here the bank will take a ump sum from the
  customer and pay out small amounts over the life
  of the annuitant, still heavily regulated