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    Chapter 18

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    Agil Mirzayev
    This chapter discusses consumer finance operations. It identifies the main sources of funds for finance companies as bank loans, commercial paper, deposits, and capital market financing. It also describes the major uses of funds as consumer loans, business loans, real estate loans, and other types of lending. Finally, it explains the risks finance companies face, such as liquidity risk, interest rate risk, and credit risk, and how their valuation depends on expected cash flows and required rates of return.

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    Download as PPT, PDF, TXT or read online from Scribd

    Chapter 18

    Uploaded by

    Agil Mirzayev
    230 views24 pages
    This chapter discusses consumer finance operations. It identifies the main sources of funds for finance companies as bank loans, commercial paper, deposits, and capital market financing. It also describes the major uses of funds as consumer loans, business loans, real estate loans, and other types of lending. Finally, it explains the risks finance companies face, such as liquidity risk, interest rate risk, and credit risk, and how their valuation depends on expected cash flows and required rates of return.

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    This chapter discusses consumer finance operations. It identifies the main sources of funds for finance companies as bank loans, commercial paper, deposits, and capital market financing. It also describes the major uses of funds as consumer loans, business loans, real estate loans, and other types of lending. Finally, it explains the risks finance companies face, such as liquidity risk, interest rate risk, and credit risk, and how their valuation depends on expected cash flows and required rates of return.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    230 views24 pages

    Chapter 18

    Uploaded by

    Agil Mirzayev
    This chapter discusses consumer finance operations. It identifies the main sources of funds for finance companies as bank loans, commercial paper, deposits, and capital market financing. It also describes the major uses of funds as consumer loans, business loans, real estate loans, and other types of lending. Finally, it explains the risks finance companies face, such as liquidity risk, interest rate risk, and credit risk, and how their valuation depends on expected cash flows and required rates of return.

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    Chapter 18 : Consumer Finance Operations

    Financial Markets and Institutions Chapter 18

    Chapter Objectives
    Identify the main sources and uses of finance company funds Describe how finance companies are exposed to various forms of risk Explain how finance companies interact with other financial institutions

    Financial Markets and Institutions Chapter 18

    Types of Finance Companies


    Consumer finance companies make direct loans to consumers Sales finance companies concentrate on purchasing credit contracts from retailers and dealers Commercial finance companies provide loans to firms that can not obtain financing from commercial banks
    Financial Markets and Institutions Chapter 18 3

    Types of Finance Companies


    Consumer

    Finance Companies

    Sales
    Financial Markets and Institutions Chapter 18

    Commercial
    4

    Sources of Finance Company Financing


    Bank Loans Commercial Paper Deposits and Capital Market Financing

    Capital
    Financial Markets and Institutions Chapter 18 5

    Sources of Finance Company Funds


    Finance companies use loans from banks as a source of funds and consistently renew the loans over time Commercial paper A short-term source but finance companies roll over their issues to create a permanent source of funds Secured commercial paper allows smaller and medium-sized firms access to the market Well-known firms use direct placement
    Financial Markets and Institutions Chapter 18 6

    Sources of Finance Company Funds


    Some states allow finance companies to accept customer deposits Bonds are used as a long-term source of funds and the use of this source depends on
    Expectations about future interest rates The balance sheet structure

    Capital comes from retained earnings or issuing stock


    Financial Markets and Institutions Chapter 18 7

    Finance Company Lending Areas


    R e a l E state L oan s $ 98.5 B illion 1 0%

    C on sum e r Lo an s $ 25 4.9 B illion 2 5%

    B usine ss L oa n s $33 5 .1 B illio n 3 3% O ther $31 3.7 B illio n 31%

    Financial Markets and Institutions Chapter 18

    Uses of Finance Company Funds


    Finance companies make many kinds of consumer loans in the form of personal loans
    Auto loans offered by a finance company owned by the manufacturer Home improvement, mobile home and other kinds of personal loans Credit cards which can be used at a variety of retail stores
    Financial Markets and Institutions Chapter 18 9

    Uses of Finance Company Funds


    Credit card loans in which a retailer sells a credit contract to a finance company
    Customers make payments to the finance company Gives the finance company access to new customers

    Financial Markets and Institutions Chapter 18

    10

    Uses of Finance Company Funds


    Business loans and leasing are used to finance the cash cycle of companies
    Cash cycle is the amount of time it takes between when inventory is purchased, the product is sold and customers pay This financing is often backed by accounts receivable or inventory

    Leveraged buy out loans Factor accounts receivable


    Financial Markets and Institutions Chapter 18 11

    Uses of Finance Company Funds


    Leasing
    Finance company purchases equipment Leases it to businesses

    Real estate loans


    Mortgages on commercial real estate Second mortgages on residential real estate

    Relative importance of uses of funds


    Financial Markets and Institutions Chapter 18 12

    Regulation of Finance Companies


    Federal regulations apply if finance companies are acting as bank holding companies or are subsidiaries of bank holding companies State regulations apply otherwise Have ceilings which put a maximum on the loans size Subject to interest rate ceilings and a maximum term for the loan
    Financial Markets and Institutions Chapter 18 13

    Balance sheet of finance company

    Financial Markets and Institutions Chapter 18

    14

    Risks Faced by Finance Companies


    Liquidity risk
    Finance companies do not hold assets that can be easily sold in the secondary market To raise funds they must borrow Balance sheet structure does not call for much liquidity because they would not have unexpected deposit withdrawals

    Financial Markets and Institutions Chapter 18

    15

    Risks Faced by Finance Companies


    Interest rate risk is less than for depository institutions because the maturity of assets and liabilities is relatively short Assets are typically not as rate sensitive as liabilities Can use adjustable rates and shorter maturities on their loans to manage the risks
    Financial Markets and Institutions Chapter 18 16

    Risks Faced by Finance Companies


    Credit risk
    Represents an important source of risk Loan delinquency rates are typically higher than for other kinds of institutions Charge a higher interest rate to compensate for the risk High return, high risk nature of loans makes performance sensitive to prevailing economic conditions
    Financial Markets and Institutions Chapter 18 17

    Valuation of a Finance Company


    Value of a finance companies depends on its expected cash flows and required rate of return
    ( V = f [( E(CF), ( k] +

    Where:
    V = Change in value of the institution E(CF) = Change in expected cash flows k = Change in required rate or return
    Financial Markets and Institutions Chapter 18 18

    Valuation of a Finance Company


    Factors that affect cash flows
    ( E(CF)= f (( ECON, ( Rf , ( INDUS, ( MANAB) + +

    Where:
    E(CF) = Expected cash flow ECON = Economic growth Rf = Risk free interest rate INDUS = Prevailing industry conditions for the institution MANAB = The ability of the institutions management
    Financial Markets and Institutions Chapter 18 19

    Valuation of a Finance Company


    Economic growth
    Positive affect because it enhances household demand for consumer goods Economic growth reduces defaults

    Change in the risk-free rates


    Cash flows inversely related to interest rate movement Short term sources of funds means their rates change as do those of other interest rates
    Financial Markets and Institutions Chapter 18 20

    Valuation of a Finance Company


    Change in industry conditions which include regulatory constraints, technology and competition Change in management abilities

    Financial Markets and Institutions Chapter 18

    21

    Interaction with Other Financial Institutions


    Interact in various ways with other financial institutions Concentration in commercial lending means they are closely related to commercial banks, savings institutions and credit unions Compete with savings institutions and increase market share when their competitors have problems
    Financial Markets and Institutions Chapter 18 22

    Participation in Financial Markets


    Participate in a wide range of financial markets
    Money markets Bond markets Mortgage markets Stock markets Futures markets Options markets Swap markets
    Financial Markets and Institutions Chapter 18 23

    Multinational Finance Companies


    Large multinational companies with subsidiaries in many countries Reasons why finance companies go global
    Enter new markets Reduce exposure to the U.S. economy

    Financial Markets and Institutions Chapter 18

    24

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