Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 11 The Investment Function in Banking The purpose of this chapter is to discover the types of securities that banks acquire for their investment portfolio and to explore the factors that a bank manager should consider in determining what securities a bank should buy or sell.
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Functions of a Bank’s Security Portfolio Stabilize the Bank’s Income Offset Credit Risk Provide Geographic Diversification Provide Backup Source of Liquidity Reduce Tax Exposure Serve as Collateral Hedge Against Interest Rate Risk Provide Flexibility Dress Up a Bank’s Balance Sheet
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Money Market Instruments Used by a Bank Treasury Bills Short-Term Treasury Notes and Bonds Federal Agency Securities Certificates of Deposit Eurocurrency Deposits Banker’s Acceptances Commercial Paper Short-Term Municipal Obligations
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Capital Market Instruments Used by a Bank Treasury Notes and Bonds Over One Year to Maturity Municipal Notes and Bonds Corporate Notes and Bonds
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Other More Recent Investment Instruments Structured Notes Securitized Assets Stripped Securities
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Investments Held By U.S. Banks
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Other Information About Investments By U.S. Banks
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Factors Affecting the Choice of Securities Expected Rate of Return Tax Exposure Interest Rate Risk Credit Risk Business Risk Liquidity Risk Call Risk Prepayment Risk Inflation Risk Pledging Requirements
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Investment Maturity Strategies The Ladder or Spaced-Maturity Policy The Front-End Load Maturity Policy The Back-End Load Maturity Policy The Barbell Strategy The Rate Expectation Approach
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Maturity Management Tools The Yield Curve Picture of How Market Interest Rates Differ Across Differing Maturities Constructed Most Easily with Treasury Securities Provides Information About Under and Over Priced Securities Provides Information About the Risk Return Trade-Off Duration Present Value Weighted Average Maturity of the Cash Flows Can Be Used to Insulate the Securities From Interest Rate Changes