FD 3 #2- FINANCE 100% ORIGINAL & A+ QUALITY WORK (9 hours)
RESPOND TO EACH OF THESE DISCUSSION QUESTIONS & NUMBER ANSWERS ACCORDINGLY
(Response 160 words each)
F36a. Mortgage Crisis Reasons and Refinancing
Following is a summary of one of the things that happened to cause the mortgage crises.
People were buying houses for which they couldn’t afford the payment on a fixed mortgage, so they opted for an ARM that had a lower rate than the fixed rate. ARMs are mortgages that reset their interest rate every few years (3, 5, or 7 years), with the new rate being based on what the market rates are at the time. Many people could barely afford the ARM they were in, but figured that they would be better off financially by the time the interest rate reset, which would allow them to be able to make the higher payments that a new interest rate would require. Or, they figured that they could refinance and get into a fixed mortgage at the time of the ARM resetting. That would require them to pay off the old mortgage and get a new mortgage.
Unfortunately, by the time that the ARM was ready to reset, the value of peoples’ homes had gone down so much that they would actually have to come up with money out of pocket to pay off their old mortgage, since the new lower appraised value of their home limited the amount of loan they could get. Thus, people were stuck with either having to come up with a large sum of cash, or to pay a higher mortgage payment as their ARM’s interest rate rose. In either case, they were being required to come up with money that they simply did not have.
As a result, many people defaulted on their mortgages and just walked away. This left the banks with having to record a bunch of write-offs, and killed the profits in that industry for a few years.
We (my wife and I) recently experienced a setback personally due to the market. We have a 30-year fixed mortgage with an interest rate of 6%, and were interested in refinancing due to the rates currently be in the 4% – 4.5% range. Unfortunately, due to the value of our home having gone down with the market downturn, we don’t have enough equity in the house (as a percentage of the home’s lower value). The banks don’t want to finance anyone that needs more than 90% of the homes appraised value, so we are stuck in this home at the rate we have. It is a shame, because now is the best time to buy a new house – interest rates are low and housing prices are pretty much bottomed out. If we could sell our current house, we could possibly buy a new one for a great price.
I think that many people are in our shoes. Until we are able to work out from this situation as a country, the housing market won’t pick up.
Do others in the class have examples of other “Catch 22” situations like this?
F36b. Market Share Leader Risks
I think that if a bank is only interested in market share, they are somewhat short-sighted. Yes, it sounds good to be able to say that “we are the biggest bank in making mortgages”, or “we have the largest number of customers in this market”, but being the biggest in a particular market or industry doesn’t mean the same as being the most profitable. If you are the biggest in a particular area that is not profitable, that is a bad thing.
For example, there may be a bank that wants to be able to say that they are the biggest lender of home equity loans. While that sounds nice, and one would normally expect that that would be a good thing, it depends on what the profitability on those types of loans is. In reality, whoever was the largest in that market when the home loan market crashed a couple of years ago actually lost in a big way. Home equity lenders are second in line for payback when a customer has a first and second mortgage. If a house has gone down in value by so much that it is even worth less than the original first mortgage, the home equity line of credit is basically an unsecured loan (since there is no asset with value that is backing up the loan (it all backs up the first mortgage)). So, in this case, this bank would have had the largest unsecured amount of loans in the industry. As the economy continued to suffer, this particular type of loan suffered from customers not paying (perhaps more so than the first mortgages), and this company had many write-offs.
So, I think that the desire to have the largest market share should be adjusted to be a desire to have the largest of the right kind of market share (the largest profitable kind). The goal of companies should be to have the largest profits, NOT the largest sales/revenue.
Does anyone have any other examples of instances when a company having a large market share actually suffered as a result? Can anyone think of a situation that could exist like this if it doesn’t already exist?
F36c. Risk Based Pricing
What is a major difference between credit unions and commercial banks? Hint: it has something to do with the fact that credit unions are not-for-profit institutions. How does the fact that they are not-for-profit impact their financial statements/cash flows?
In addition to being a customer of my employer (95% of my banking needs are with them), I am a member of a credit union. It has been my experience that commercial banks price the interest they charge on loans in large part based on the borrower’s credit score/history, and use that history to determine whether to give the customer the loan or not. This is called risk-based pricing. The loan is not restricted to current bank customers.
On the flip side, credit unions charge interest on loans at the same rate for all customers. The borrower’s credit history will impact whether or not a loan is even made, but once the decision to make the loan has been made, the interest rate charged is the same for all customers. Finally, credit unions can only make loans to members, so not all borrowers are eligible to even apply for a loan with all credit unions.
What is everyone’s opinion about risk-based pricing? Does it seem “fair”? Why or why not?
F36d. Describe an interest rate risk you face in your personal life. How is it different from a credit risk? Which is easier to manage? Explain your answer.
F36er. Credit risk is an interesting subject, especially as it relates to personal credit scores. Most people would assume that if someone has little to no debt (and never did), they would actually be a good risk for a lender, since there would no other lenders competing for the borrower’s payments. However, a situation like this is a little tricky for a lender, since they really have no “track record” of how the borrower pays on money that they have borrowed. Sure, they may have no debt, but if they have never really learned how to borrow and make payments, they may not be a reliable borrower.
Situations like this are reflected in credit scores, as someone with little credit history may actually have a lower credit score than someone with a lot of debt that always pays back their loans. It almost seems as if there is some “sweet spot” of borrowing and paying back loans that results in the highest credit scores. Borrowing too little hurts the credit scores, as does borrowing too much.
There are several other factors that can impact a person’s credit score. Can anyone name some other factors? Does anyone have any credit score experiences that they care to share with the class?
F36f. Foreign stocks may present a risk. Explain those risks in terms of exchange versus country or sovereign risk. Do you believe foreign markets are more stable than domestic markets? Explain your answer.
F36g. I can see how you feel about being charged a fee to access your own cash, as you rightfully feel that it is your money, and you should have access to it all. On the other hand, I also understand that banks have to maintain a huge infrastructure to support the myriad of ways you have access to your money – ATM’s, debit cards, checks, online, mobile banking (via phone), etc. This infrastructure costs money to maintain, and people to maintain it. If the very customers that use this infrastructure can’t be billed for it, who can?
I would say that if banks are not allowed to charge fees for these services, they will eventually have to refuse service to anyone that doesn’t maintain a minimum balance in their account. This would put you further behind the eight ball, as your choices in where to bank will be severely diminished. Simply put, those customers that don’t maintain a certain balance with a bank, or that don’t have other services with that bank (credit cards, loans, investment accounts) are not profitable without being able to charge fees. Banks are in the business to make a profit for their shareholders, while providing a valuable service to their customers. If customers feel strongly enough about the fees that they are being charged for certain products/services, they have the right to not use that product/service, or to take their business to other institutions that don’t charge those fees (credit unions, online banks maybe, etc.). If enough customers do that, the bank may rethink their strategy and change some of their policies/fees.
I believe that the customer is always the one that pays for things in the end. As a customer, I may not like this, but I realize that whenever there is government regulation, or some other increase in the costs of running a business (such as gas prices affecting even the price of groceries), the cost is passed onto the consumer. If a company does not pass on these expenses to the consumer, they will make less money, and may eventually go out of business. If it is a publicly traded company, if it eats these costs, the return to shareholders is reduced. This may not sound like it impacts the average Joe, but anyone that has a retirement plan or a 401K can suffer if their plan happens to hold shares of this company.
I hope I haven’t offended anyone with my thoughts – I’m just trying to share one person’s opinion, and would encourage others to respond with their thoughts as well. You absolutely have raised good points, and I appreciate you bringing them up. In the end, we are all consumers, and I think that we all want our expenses to be as low as possible – we may just differ on how we think we need to get there.
F36h. Briefly summarize what you have learned from the 7 discussions above (F36a to F36g). What did you learn that you had never even thought about before? Did you have an “Ah-ha” moment when a light bulb came on in your head? What did you previously know a little about that you gained a greater understanding of? Finally, what do you consider important that you learned this week, and why?
F48 a. In your own words, explain capital budgeting. Why is it important to a companyâ€™s long-term success? Provide an example of poorly performed capital budgeting. How does this affect a companyâ€™s long-term success?
Why is capital budgeting part of a companyâ€™s long-term strategic planning process? What are the pros and cons of these methods:
o Simple payback
Which would you recommend using? Why? Would your recommendation differ
F48b. In your own words, explain the concept of cost of capital. How may cost of capital affect long-term financial decisions? Would a company prefer to have a high or low cost of capital? Why? What was the effect of cost of capital on long-term financial decisions for your company?
What are major areas of risk in financial management? What are major areas of financial risk in your company? Which risk management techniques are important to your company? Why?
F48b2. As an aside to this set of questions,
I would like your opinions——–
Do you think Political Risk would be considered a Financial Management risk and why.