Faculty
Professor Dennis E. Logue
Objectives
The financial landscape has changed dramatically over the past year. Despite changes in ownership, organizational form, and an emerging (stringent) regulatory regime, the roles of Financial Service Firms (FSFs) remain unchanged. But the current crisis is partially attributable to the fact that many FSFs deviated from their true roles.
This course will deal with the roles of various kinds of FSFs and with the management challenges each type of firm (or decision of a larger financial conglomerate) faces. Of course, we will spend time discussing cause, consequences, and potential cures of the current crisis, but it is my hope that our key focus will be upon the “eternal verities”.
Management of Financial Institutions in intended not only for those interested in careers in FSF, but also for those who wish to extend their institutional, industry specific knowledge. This might aptly be described as a survey course, though we shall probe deeply in certain areas. We will cover banks, insurance companies, investment banks, hedge funds, mutual funds, and trading markets. Though the distinctions amongst these FSFs are blurring, there are still some distinctions. We will emphasize management issues such as risk management and regulatory compliance, but we will also touch upon some public policy concerns, for example TARP, the mortgage crisis and proposals for regulatory reform.
The course consists of a blend of lectures, case studies, and guest speakers.
Requirements
You are expected to attend all classes, to have read assigned readings, to have prepared answers to the study questions, and to have prepared assigned cases.
During the term, there are four assigned case studies. Two will be eligible for individual write-up. Choose either the Banc One case or the Subprime Meltdown case to render a written analysis on your own. A third case study, HSBC, is a group project, and randomly selected groups will be given the opportunity to present their analyses to the class. The fourth case study will be used for class discussion and helps with an historical perspective.BR>
Though each case assignment lists questions to help you get a handle on key case issues, I do not necessarily want direct answers to these questions. I would like you to follow the following format:
Issue: Identify the chief decision (s) confronting management in the case. e.g. Should we concentrate all securities trading on one network?
Analysis: Discuss the pros and cons of alternative courses of action.
Recommendation: Indicate what management should do and why.
Individual case write-ups should be no longer than three double spaced pages, and they
are due at the start of the class on the day which they are assigned.
In addition, there will be two group projects. One is relatively modest, while the other may be a bit more demanding. A group consists of no fewer than three or more than six students.
BR>
Group Project I: The HSBC case. The issue here is what should HSBC do about becoming a global bank? This combines financial and strategic issues. We shall set aside a class period during the term to allow randomly selected groups to make their presentations to peers. The paper should be no longer than four pages. Regarding the presentation, try to keep it to 15 minutes and no more than 7 to 10 power point slides. Note: if slides tell the whole story, there is no need for additional written material.
Group Project 2: This requires the group to pick a topic of interest to its members, research it, write about it, and report findings to the class. Pick any issue you wish that has to do with FSFs or markets. This could be a broad policy issue, e.g. what should the government do about mortgage markets. Or, it could be more managerially oriented, e.g.
what would you recommend to the new management at Citigroup. The paper should be no more than 10 pages and presentation slides should number fifteen or fewer.
I would be pleased to discuss appropriate topics with you. I would also like to have a short (one sentence or two) write-up about your topic and a list of team members by April 11th.
Materials
Text: F.S. Mishkin & S. G. Eakins, Financial Markets & Institutions, 6th edition.
Pearson-Addison Wesley, 2009 (M&E)
This text will be on reserve at Feldberg or you can buy a copy. Roughly half of the book
will be assigned. The other half is redundant to material you covered in first year
required courses. However, this is a good book, and one of its co-authors, Mishkin, recently left the Board of Governors of the Fed., so much should be quite topical. Accordingly, there might be some insights in the text that will help you guess what the Fed will do.
I will also assign some chapters from a book on financial markets. This book will be on
Reserve at Feldberg:
L. Harris, Trading & Exchange, Market Microstructure for Practioners, Oxford Univ.
Press, 2003
Note: check course folder prior to each lecture for updated materials.
Tuck Honor Code
The individual case write-up must reflect individual work, that is no study group discussion. The group case should reflect work done by that group alone. The group research projects must reflect original work. The Tuck Honor Code applies.
Laptop Policy
Laptops may be used in class for note-taking purposes and presentation purposes only. Web-surfing, e-mailing, love notes are not allowed.
Grading
Individual Case Write-up 20%
Group Case Presentations 20%
Group Research Project 40%
Class Participation 20%
Schedule
Session 1
Tuesday, March 24
Overview of Financial Institutions & Markets
Read:
Mishkin & Eakins, Chapter 1,2
Questions:
What are the basic financial needs of households, firms and the government? Virtually every financial need you can think of can be categorized as fundamental needs. The first is to transfer value through time (to borrow or lend).
What prevents households and firms from meeting those financial needs by simply buying and selling securities in financial markets? For instance, consider the need to transfer value through time. Many borrowers and lenders can meet that need directly in the credit markets (for instance, firms and governments both sell bonds directly to investors; and firms provide trade credit directly to their customers as accounts receivable). But most borrowers and lenders cannot meet their borrowing and lending needs in this direct way, why not? Make a list of 8 or 9 basic problems with financial markets that prevent households, firms and the Government from meeting their basic needs through direct exchange in financial markets.
How do financial intermediaries help overcome these market failures to meet the basic financial needs of households and firms that financial markets cannot meet? Consider for instance the role of banks. They bring borrowers and lenders together by taking deposits (from lenders) and making loans (to borrowers). In doing that they solve some of the problems that markets have in bringing lenders and borrowers together directly.
Which basic financial needs cannot be met by either financial markets or financial intermediaries? Think of three financial services that you would value but do not have access to. For instance: what type of asset classes do you not have access to, what risks would you like to insure but cannot, or what financial information do you not have that you would value?
How do legal systems shape financial systems?
What’s happened to the system that has reduced its effectiveness?
Session 2
Wednesday, March 25
Banks
Read:
Mishkin & Eakins, Chapters 15, 17, 18
“The Spectre of Nationalisation”, The Economist, Jan. 24, 2009
Richard Brealey “Basel II: The Route Ahead or Cul-de-Sac”, Journal of Applied Corporate Finance, fall 2006
Questions
What functions do banks perform that firms and households cannot do for themselves?
What are the differences between banks assets and bank liabilities? How do banks transform the cash flow of borrowers (loans) into the cash flow to lenders (deposits)?
Why do governments insure bank deposits?
What are the core competencies of banks?
Session 3
Monday, March 30
Regulation of Financial Service Firms
Read:
Mishkin & Eakins, Chapters 16, 20
Questions:
The financial services sector is probably the most heavily regulated industry in the U.S. as well as in many other parts of the world. Why is this?
How might one go about assessing the effectiveness of regulation in light of its costs? For instance, in the early 1960’s Nobel Laureates George Stigler showed that the market for IPOs was pretty much the same before and after the inauguration of the SEC. Can this evidence be extrapolated to other markets and institutions?
What gaps in current regulations has the recent financial crisis exposed? How can they be fixed?
Session 4
Tuesday, March 31
Risk Management
Read:
Note on Credit Derivatives (HBS 9-205-111)
Value at Risk
Financial Economists Roundtable statement on rating agencies.
“Greed-and Fear”, The Economist, January 24, 2009
Rene Stulz, “Risk Management Failures: What Are They and When Do They Happen?”, Journal of Applied corporate Finance, Fall 2008
Brian Nocco, Rene Stulz, “Enterprise Risk Management: Theory and Practice”, Journal of Applied Corporate Finance, Fall 2006
Questions:
For any organization, there are four fundamental ways of reducing and controlling risk. What are the four ways? (Note: This is true for any corporation and all types of risk).
How do banks control credit risk in each of these four ways?
Banks are expert in assessing credit risks. What other types of firms create value by assessing credit risk? Credit rating agencies are one example, but who else?
In most markets, prices adjust until supply and demand for the product are roughly equal, or moving toward equilibrium (prices clear the market). But consider the markets for credit. For any type of lending, the price is the interest rate. Do interest rates adjust to clear credit markets, or is there usually an excess demand for or, alternatively, and excess supply of credit? Which is it, and why? Is this what has happened recently?
Banks, insurance companies, and hedge funds assets and liabilities have different sensitivities to interest rate changes, putting these FSFs at risk to shifts in interest rates. But, is interest rate risk really a big deal? Can you think of any examples where FSFs have been crippled by changes in interest rates? Are interest rates troubling now?
How does interest rate risk control differ between big FSF’s (money center and large regional banks) and small FSFs (small regional and community banks)?
How is liquidity created? What are the big sources of liquidity and the big sinks of liquidity in the economy?
How does liquidity contraction or expansion propagate across financial markets? Consider, for example, a liquidity event like the Russian Government’s default on its own Ruble denominated debt in August 1998. Within days of the collapse of that market, the liquidity in seemingly unrelated markets, like the US mortgage debt market or the US high yield market, had shrunk dramatically. How does that propagation of a liquidity event across markets actually work? How has it worked during the sub-prime mortgage crisis?
Why have some probability based risk assessment models failed?
Do you have any issue with credit default swaps?
Session 5
Monday, April 6
Asset & Liability Management
Read:
Mishkin & Eakins, Chapter 24, 25(skim)
Case:
Bank One Corporation (HBA 9-294-079)
This case is eligible for individual write-up. (This is seemingly dated, but it really gets at corrupt issues)
Questions:
If Banc One wanted to manage its interest rate exposure without using swaps, what could it do? How could it move from asset sensitive to liability sensitive? Work through the Appendix.
What are AIRS? How do they work? Why is Banc One using them so extensively?
What are basis swaps? Why has Banc One recently increased its basis swap position?
How might its derivatives portfolio be damaging the banks stock price? What worries investors?
What should McCoy do?
(note: Jamie Dimon left Citigroup and headed Banc One, he used this position to build Banc One into JP Morgan Chase.
Session 6
Tuesday, April 7
Trading Markets
Read:
Mishkin & Eakins, Ch. 11 (skim)
Harris, Chapters 3, 4, 5 27
J. Macy & M. O’Hara “From Orders to Markets”, Regulations, summer 2005
Wall Street’s First Panic (A) (HBS 9-708-002)
Questions:
What are the most desirable features of a trading Market?
Financial markets around the globe were organized as mutual associations until quite recently when they became public companies. Why do you think this happened?
Session 7
Monday, April, 13
The Current Mess
Read:
Mishkin & Eakins, Chapter 12
S. Chomsisengphet & A. Pennington-Cross “The Evolution of the Subprime Mortgage Market”, St. Louis Fed Review, Jan/Feb 2006
Case:
Subprime Meltdown: American Housing and Global Financial Turmoil. (HBS 9-708-042)
(Note: This is eligible for individual write-up.)
Questions:
What accounts for the subprime turmoil which burst onto the scene in mid 2007? Who is responsible?
Has the US/global financial system responded well or poorly? Might this strike again?
What is your assessment of the Fed’s performance?
What are short term and long term remedies?
Session 8
Tuesday, April 14
Emerging Issues
Read:
Intro to Islamic Finance (HBS 9-200-002)
Group of 30, Financial Reform: A Framework for Financial Stability, Jan. 2009
Fact Sheet, Financial Stability Plan
TBA
Questions:
Will Islamic Banking ever be useful as a serious competitive weapon for Western banks?
Consider the reforms. Which do you like, which are flawed? Why?
Session 9
Monday, April 20
Specialty Finance
Read:
Commercial Financial Services (HBS 9-299-023)
Look at two companies: C-Bass-Com and Shermfin.com, respectively
Decade After Scandal (course folder)
Session 10
Tuesday, April 21
Banks in Crisis
Read:
Capital Raise Proxy (course folder)
Merger Proxy (course folder)
Session 11
Monday, April 27
Hedge Funds
Read:
T.F. Edwards & S. Gaon, “Hedge Funds: What do we know?” Journal of Applied Finances, summer 2003
Alternative Investment Survey (course folder)
Global Risk Disclosure (course folder)
Session 12
Tuesday, April 28
Investment Banking (group case presentation)
Read:
Mishkin & Eakins, Chapter 23
A. Morrison & W. Wilhelm “Investment Banking: Past, Present and future,” Journal of Applied Corporate Finance, winter 2007
R. Smith, “Strategic Directions in Investment Banking” Journal of Applied corporate Finance, 2001
Case:
HSBC
Questions:
Why does HSBC want to become a major force as a global wholesale and investment bank as well?
What is the main risk to HSBC shareholders in creating a global investment banking business?
Why has HSBC failed so far despite a powerhouse global banking platform?
What should HSBC do next regarding its investment banking ambitions?
Session 13
Monday, May 4
Mutual Funds
Read:
Mishkin & Eakins, Ch. 21
TBA
Session 14
Tuesday, May 5
Insurance
Read:
Mishkin & Eakins, Ch.22
Flagstaff Reinsurance 10K (course folder)
Session 15
Monday, May 11
Central Banking
Read:
Mishkin & Eakins, Ch. 7, 8
TBA
Session 16
Tuesday, May 12
Capital Markets
Read:
TBA
Session 17
Monday, May 18
Student Presentations
Session 18
Tuesday, May 19
Student Presentations
