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liquidity
access to sufficient (the right amount) immediately spendable funds at reasonable cost exactly when those funds are needed; either already have them or can raise them by borrowing or selling assets
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net liquidity position (Lt)
the difference between the volume of liquid funds available & the demand for liquid funds; D > S = this < 0 = liquidity deficit; S > D = this > 0 = liquidity surplus
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asset conversion
a strategy for meeting liquidity needs in which liquid reserves are stored readily in marketable assets (cash & securities) that can be quickly converted to cash
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liquid asset
one that meets 3 conditions: price stability (can be sold without a significant decline in price), ready marketability (can be converted to cash without delay), & reversibility (original investment/principal can be recovered with little risk of loss)
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opportunity cost
forgone income that isn't earned because idle funds haven't been invested in earning assets; the yield available on the next best alternative use of an individual's or institution's funds
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liability management (purchased liquidity)
use of borrowed immediately spendable funds to meet liquidity needs, in which a financial institution attracts the volume of liquidity needs by raising or lowering the rate of interest it's willing to pay on borrowed funds
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balanced liquidity management
the combined use of both asset management & liability management to cover liquidity needs = some of the expected demands for liquidity are stored in assets (mainly marketable securities) while other anticipated liquidity needs are backstopped by advance arrangements for lines of credit from potential suppliers of funds
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sources & uses of funds approach
developed for estimating liquidity requirements that examines the expected sources of liquidity (deposits) & the expected uses of liquidity (loans) & estimates the net difference over a given period of time in order to aid liquidity planning
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liquidity gap
the amount by which the sources and uses of liquidity don't match; measured by the size of the difference between the two
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liquidity indicator approach
certain financial ratios that are used to estimate liquidity needs and to monitor changes in liquidity position
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money position manager
managerial position that's responsible for ensuring that the institution maintains an adequate level of legal reserves to meet its reserve requirements as set by law & also have access to sufficient quantities of reserves to accommodate customer demand & meet other cash needs
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legal reserves
assets that by law must be held behind deposits or other designated liabilities; in the U.S. these consist of vault cash & deposits at the Federal Reserve banks
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reserve computation period
established by the FRS for certain depository institutions over which the daily average amounts of various deposits (& vault cash) are computed to determine their legal reserve requirement ; Tuesday- Monday 2 weeks later
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reserve maintenance period
according to federal law & regulatio a depository institution must hold the daily average amount of legal reserves it's required by law to hold behind its deposits & other reservable liabilities; Thursday- Wednesday 2 weeks later
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clearing balances
deposits held with the Federal Reserve banks by depository institutions to help clear checks for pay & collection; allow the depository institutions using the Federal Reserve services to earn interest credits on these in order to help offset the cost of Fed services
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sweep accounts
contracts executed between a depository institution & some of its deposit customers that allow the institution to transfer funds (usually overnight) out of the customers' checking accts. into their savings accts. or into other types of deposits that don't carry legal reserve requirements
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asset-liability management (ALM)
the process of decision making to control a financial institution's exposure to interest rate risk; look at asset & liability portfolios as an integrated whole; to limit a bank's losses in NI & Equity
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asset management
a mgmt strategy that regards the volume & mix of a financial firm's sources of funds as determined largely by the wishes of its customers (the public) & calls for mgmt to concentrate on controlling assets, rather than on managing liabilities, in order to meet liquidity needs & other goals
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liability management
use of borrowed funds to meet liquidity need, in which a financial institution attracts the volume of liquidity it needs by raising or lowering the rate of interest it's willing to pay on borrowed funds
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funds management
combining asset & liability management strategies in order to achieve a financial institution's goals & meet its liquidity needs more effectively; exercise control as much as possible over the volume, mix, & return or cost of both; mgmt's control of both should be coordinated; develop policies that maximize returns & effectively control costs on both sides
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interest rate risk
the probability that rising or falling interest rates will adversely affect the margin of interest revenues over interest expenses or result in decreasing the value of net worth
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yield to maturity (YTM)
the expected rate of return on a debt security held until its maturity date is reached, based on the security's purchase price, promised interest payments, & redemption value at maturity; the discount rate that equalizes the current MV of a loan or security w/ the expected stream of future income payments that the loan or security will generate
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bank discount rate
the method by which yields on Treasury bills (short-term loans) & other money market securities are calculated using par value & a 360-day year to determine the appropriate yield
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interest-sensitive gap management
mgmt techniques that usually require a computer analysis of the maturities & repricing opportunities associated with interest-bearing assets, deposits, & money market borrowings in order to determine when & by how much a financial institution is exposed to interest rate risk
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duration gap management
a strategy or technique used by the management of a financial institution to achieve a desired spread between the duration of its assets & the duration of its liabilities in order to control the institution's interest-rate risk exposure
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duration
a PV-weighted measure of the maturity of an individual security or portfolio of securities in which the timing and amount of all cash flows expected from the security or portfolio of securities are considered; of promised stream of future cash payments (receive from loans or pay out to depositors); measures avg time needed to recover the funds committed to an investment
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real estate loans
credit secured by real property, including short-term credit to support building construction & land development & longer-term credit to support purchase of residential (homes, apartments) & commercial structures
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financial institution loans
both long- & short-term credit extended to banks, insurance companies, finance companies, & other financial institutions
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agricultural loans
credit extended to farm & ranch operations to assist in planting & harvesting crops & to care for (feeding) & market livestock
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commercial & industrial loans
credit granted to businesses to help cover purchases for inventory, plant & equipment, paying taxes, meeting payrolls, & to meet other operating expenses
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loans to individuals
credit extended to households to finance the purchase of automobiles & appliances, medical & personal expenses, & other household needs
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wholesale lenders
lending institutions that devote the bulk of their credit portfolios to large-denomination loans extended to corporations & other relatively large business firms & institutions
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retail credit
smaller-denomination loans (personal cash & home mortgage loans) extended to individuals & families as well as to smaller businesses
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CAMELS rating
a system that assigns a numerical rating to a depository institution based on examiner judgment regarding its capital adequacy, asset condition, management quality, earnings record, liquidity position, & sensitivity to market risk
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cash flow
often measured by NI plus noncash expenses (such as depreciation) of a business loan customer; sales revenues - COGS - selling, general, & administrative expenses - taxes paid in cash + noncash expenses
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loan review
a process of periodic investigation of all outstanding loans to make sure each loan is paying out as planned (borrowers are adhering to their credit agreements), all necessary documentations is present, & loan officers are following the institution's loan policy; from this the institution's over exposure to risk & possible need for capital in the future can be assessed
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loan workouts
activity within a lending institution that focuses on delinquent loans (problem loans= borrower missed 1 or more payments or collateral pledged has declined significantly in value) & tries to develop & implement strategies designed to recover as much funds as possible from troubled borrowers
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self-liquidating loans
business loans, usually to support the purchase of inventories, in which the credit is gradually repaid by the borrowing customer as inventory (raw materials or finished goods) is sold; take advantage of the normal cash cycle
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working capital loans
loans that provide businesses with short-term credit lasting from a few days to 1 year & that are often used to fund the purchase of inventories in order to put goods on shelves or to purchase raw materials; to cover seasonal peaks
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interim construction loans
secured short-term lending to support the construction of homes, apartments, office buildings, shopping centers, & other permanent structures; temporary
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asset-based loans
loans secured by a business firm's assets, particularly AR & Inv; credit secured by the shorter-term assets of a firm that are expected to roll over into cash in the future
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syndicated loans (SNC's)
a loan or line of credit extended to a business firm by a group of lenders in order to reduce the credit risk exposure to any single lending institution; may be used to support business operation or expansion, security issue, or other venture; often involved millions or billions of $ in credit
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compensating deposit balances
required deposits a customer must keep with a lender as a condition for getting a loan; may be required with working capital loans
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security dealer financing
dealers in securities need short-term financing to purchase new securities and carry their existing portfolios of securities until they are sold to customers or reach maturity; dealer pledges their holdings of government securities as collateral; overnight to a few days
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retailer and equipment financing
lenders support installment purchases of automobiles, home appliances, and other durable goods by financing the receivables that dealers selling these goods take on when they write installment contracts to cover customer purchases
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term loans
credit extended for longer than 1 year & designed to fund longer-term business investments, such as the purchase of equipment or the construction of new physical facilities (secured by FA= plant or equipment)
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revolving credit line
a financing agreement that allows a business customer to borrow up to a specified limit, repay all or a portion of the borrowing, & reborrow as necessary until the credit line matures; 1 of the most flexible of all business unsecured loans;may be short-term or long-term; normally has a loan commitment fee
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project loans
credit designed to finance the construction of FA that are expected to generate a flow of revenue in future periods sufficient to repay the loan & turn a profit; most risky of all business loans
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LBOs (leveraged buyouts)
contractual agreements in which a company or small group of individual investors purchases a business or buys a portion of a business firm's assets with heavy use of debt & relatively little equity capital & relies on increased earnings after the business is taken over to retire the debt
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working capital
the CA of a business firm (consisting principally of cash, AR, Inv, & other assets expected to roll over into cash within 1 year); CA - CL; if a firm is able to meet its short-term obligations from its holdings of CA
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contingent liabilities
debt obligations that will not come due unless certain events occur, such as borrower default or the exercise of product warranties (ex. guarantees behind the product, litigation or pending lawsuits against the firm, taxes owed but unpaid, limiting regulations); can turn into actual claims against the firm's assets & earning at future dates & reduce funds available to repay a loan
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price leadership
a method for setting loan rates that looks to leading lending institutions to set the base loan rate
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prime rate
an administered interest rate on loans quoted by leading banks & usually set by a vote of each bank's BOD; the interest rate that the public usually thinks is the best (lowest) rate for loans & that a bank quotes to its biggest & best customers (principally large corporations); a.k.a base or reference rate
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London Interbank Offered Rate (LIBOR)
on short-term Eurodollar deposits, which range in maturity from a few days to a few months; used as a common basis for quoting loan rates to corporations & other large borrowers
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below-prime pricing
interest rates on loans set below the prevailing prime rate, usually based on the level of key money market interest rates (such as the current market rate on Federal funds or Eurodollar deposits)
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customer profitability analysis (CPA)
a method of evaluating a customer's loan request that takes into account all revenues & expenses associated with serving that particular customer & calculates an expected net return over all costs incurred from serving the customer
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residential mortgage loans
credit to finance the purchase of homes or fund improvements on private residences; ex. home mortgage or home equity loan; usually longer-term (15-30 years), secured by the property itself, has either a fixed or variable (floating) IR; banks leading lenders of these
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installment loans
credits that are repayable in 2 or more consecutive payments, usually on a monthly or quarterly basis; loans for auto, education, furniture, & applicances; short to medium term
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noninstallment loans
short-term loans individuals & families draw upon for immediate cash needs that are repayable in a lump sum; for small amounts, require payment in 30 days or less; can be longer & of a larger amount for wealthier people; for vacations, medical care, & auto & home repairs
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credit bureaus
a business firm that keeps data files on people who have borrowed money, indicating their previous record of loan repayments
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cosigner
a person obligated to support the repayment of a loan by a borrower who either has no credit record or has such a poor track record of repaying loans that they can't get a loan without the support of this person; if borrower defaults this person must make good on the loan; borrower may feel stronger obligation to repay knowing the other person's credit rating is on the line as well
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right to offset
the legal authority of a lender that has extended a loan to 1 of its customers to call a loan that is in default & seize any checking or savings deposits the customer may hold with the lender in order to recover the lender's funds; an additional protection against the risks of consumer lending
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credit scoring
the use of a discriminant equation to classify loan applicants according to the probability of their repaying their loans, based on customer characteristics, such as their credit rating or length of employment
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disclosure rules
laws & regulations that mandate telling the consumer about financing costs & other essential terms of a loan or lease agreement, deposit contract, or other financial service
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Fair Credit Reporting Act
authorizes U.S. consumers to review their credit records, as reflected in the files of a credit bureau, for accuracy & to demand the investigation & correction of any inaccuracies promptly; restricts access to a consumer's credit files & requires their written consent
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Fair Credit Billing Act
enacted by the U.S. Congress in 1974 that permits consumers to dispute alleged billing errors committed by a merchant or credit card company & requires that consumers receive a prompt investigation of any billing disputes under penalty of forfeiture of at least a portion of the amount billed (if they don't respond or investigate)
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Fair Debt Collection Practices Act
passed by the U.S. Congress that limits how far a creditor or collection agency can go in pressing a loan customer to pay up; can't harass a debtor, calls placed at unusual times or at their place of work are illegal unless given permission, can't disclose purpose of call to anyone else except the debtor
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predatory lending
granting loans to weaker borrowers & charging them excessive fees & IR, increasing the risk of their defaulting on those loans; an abusive practice often associated with home mortgage and equity loans; may insist on excessive loan insurance well beyond what is needed to cover actual loan risk
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subprime loans
credit granted to borrowers who credit rating is considered to be weak or below average, often due to a prior record of delinquent payments, bankruptcy, or other adverse developments
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home equity loans
credit extended to an individual or family on the basis of the spread or gap between the estimated MV of a home & the amount of mortgage loans outstanding against the property; can be used as collateral for a loan to remodel the home, purchase a second home, or some other legitimate purpose; longer term, more secure, carries lower loan rate, & longer payout period
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option ARM (adjustable rate loans)
home mortgage loan that allows the borrower to pay a reduced amount the first few years (such as paying interest only) & then requires larger payments (including principal) in the later years
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annual percentage rate (APR)
interest rate on a loan that the U.S. Truth-in-Lending Act requires to be quoted to a household consumer seeking a loan; equates expected total payments with the amount of the loan; takes into account how fast the loan is being repaid & how much credit the customer will actually have use of during the life of the loan
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simple-interest method
a method for calculating the interest rate on a loan that adjusts for the declining balance on a loan & uses a formula, principal times interest times time, to determine the amount of interest owed; adjust for the length of time a borrower actually has use of credit=customer saves on interest as the loan approaches maturity
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discount rate method
the procedure used to assess interest on a loan in which interest is deducted up front at the beginning of the loan & the customer receives for their use the full principal of the loan less the interest assessed
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add-on method
a procedure for calculating a consumer's loan rate in which interest is assessed on the full principal of an installment loan; this rate will equal the simple interest rate ONLY when the loan is paid off in a single lump sum
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Rule of 78s
a method for calculating rebates of interest payments to be returned to a customer if a loan is retired early; used to determine how much interest income a lender is entitled to accrue at any point in time from a loan that is being paid out in monthly installments
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fixed-rate mortgages (FRMs)
loans against real property whose rate of interest does not change during the life of the loan; used from the 1930's-1970's to finance purchases of new homes
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adjustable-rate mortgages (ARMs)
loans against real property whose rate of interest periodically adjust to changes in market interest rates; offer lower initial interest rates, which allows more families to qualify
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points
an up-front fee often charged a borrower taking on a home mortgage, which is determined by multiplying the loan amount by the # of percentage points assessed the borrower; allows the lender to earn a higher effective IR; reduces the amount of the loan available
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