Understanding Financial Markets and their Structures - Prof. Bocchialini, Sintesi del corso di Mercato Finanziario

Scarica Understanding Financial Markets and their Structures - Prof. Bocchialini e più Sintesi del corso in PDF di Mercato Finanziario solo su Docsity! Libro institutions summarized WHY STUDY FINANCIAL MARKETS AND INSTITUTIONS? CHAPTER OVERVIEW In the 1990s, US financial markets boomed, with the Dow Jones Industrial Index (DJIA) rising from 2,800 to over 11,000 by the decade's end. The early 2000s saw a downturn, and the DJIA fluctuated due to economic issues, peaking at 14,000 in 2007 before falling due to the subprime mortgage crisis, which led to a full-blown financial crisis by 2008. The DJIA fell to 6,547 in 2009 but recovered to over 11,000 by 2010, surpassing its pre-crisis high by 2013. It peaked over 27,300 in 2019 before dropping below 20,000 in March 2020 during the Coronavirus pandemic. The 2008-2009 financial crisis had global impacts, causing significant market swings worldwide. European markets struggled with debt crises in countries like Greece, Portugal, Spain, and Italy. China’s economic growth also slowed, exacerbated by a trade war with the US. Brexit in 2016 further shook global markets, causing drops in stock prices and currencies. The Coronavirus pandemic in 2020 led to a substantial market downturn, with the DJIA dropping 32.5% in just over a month. Historically, the banking industry offered a full range of financial services, but the 1930s economic collapse led to separation. The 1970s and 1980s saw new, unregulated financial services, but recent decades have seen a reintegration of services under financial holding companies. For example, JPMorgan Chase offers banking, investment, and insurance services. The financial crisis reshaped financial institutions (FIs), leading to the collapse or restructuring of major investment banks. Legislation like the "Volcker Rule" aimed to separate FI activities again. The book provides an analysis of the financial system, emphasizing the importance of understanding the flow of funds, risks faced by investors, and strategies for risk management. It also discusses newer financial operations like asset securitization and derivative securities. The book highlights the impact of the financial crisis on markets and institutions. Financial markets are categorized by the characteristics of exchanged instruments, with FIs playing a crucial role in their functioning. FIs provide efficient ways to channel funds and played a significant role in the events leading to the late 2000s financial crisis. The chapter offers an overview of financial market structures and FI operations, with a detailed discussion of the financial crisis available in an appendix. Overview of Financial Markets Financial markets are structures where funds flow and can be categorized along two dimensions: primary vs. secondary markets and money vs. capital markets. Primary Markets: • Definition: Markets where corporations raise funds by issuing new securities. • Example: Initial Public Offerings (IPOs), such as Uber's $75 billion IPO in 2019. • Process: Investment banks (e.g., Morgan Stanley) act as intermediaries, providing advice and attracting initial public purchasers. • Impact of Financial Crisis: The financial crisis of 2008 significantly reduced primary market sales from $2,389.1 billion in 2007 to $1,068.0 billion in 2008. As of 2018, sales had only partially recovered to $1,725.2 billion. Secondary Markets: • Definition: Markets where previously issued financial instruments (like stocks) are traded. • Function: Provide a centralized marketplace for economic agents to quickly and efficiently buy and sell securities, saving search and transaction costs. • Examples: New York Stock Exchange (NYSE), NASDAQ. • Benefit to Investors: Liquidity, the ability to trade securities at market value quickly, and the availability of various risk-return characteristics. • Benefit to Issuers: Information on the market value of their financial instruments and the perceived value of the corporation by investors. Types of Markets: • Money Markets: Trade debt securities or instruments with maturities of less than one year. • Capital Markets: Trade debt and equity instruments with maturities of more than one year. • Foreign Exchange Markets: Handle cash flows from the sale of products or assets in foreign currencies. • Derivative Markets: Trade derivative securities, whose payoffs are linked to other securities or indices. Impact and Dynamics: • The financial crisis of 2008-2009 had global impacts, causing market swings worldwide. • Primary markets are crucial for raising new funds, while secondary markets provide liquidity and information on market values. • Derivative markets have grown significantly since the 1980s, becoming important financial markets. Money Markets versus Capital Markets Money Markets: Money markets are platforms for trading debt securities with maturities of one year or less. These markets cater to economic agents who have short-term excess funds and those who need short-term funding. Because of their short maturity, these instruments typically exhibit minor price fluctuations in secondary markets. In the U.S., money markets operate over-the-counter (OTC) via telephones, wire transfers, and computer trading. Money Market Instruments: 1. Treasury Bills (T-bills): Short-term obligations issued by the U.S. government. 2. Federal Funds: Short-term funds transferred between financial institutions, usually for no more than one day. 3. Repurchase Agreements (Repos): Agreements where one party sells securities to another with a promise to repurchase them at a specified date and price. 4. Commercial Paper: Short-term unsecured promissory notes issued by companies. 5. Negotiable Certificates of Deposit (CDs): Bank-issued time deposits with specified interest rates and maturity dates, which are negotiable. 6. Banker’s Acceptances: Time drafts payable to sellers of goods, with payment guaranteed by a bank. In 2019, the most substantial amounts in U.S. money markets were federal funds and repos, followed by Treasury bills, negotiable CDs, and commercial paper. Capital Markets: Capital markets trade equity (stocks) and debt (bonds) instruments with maturities exceeding one year. These markets are vital for corporations and governments, the primary users of funds, while households are the main suppliers. Capital market instruments are subject to wider price fluctuations compared to money market instruments due to their longer maturities. Capital Market Instruments: 1. Corporate Stock: Represents ownership in a public corporation. 2. Mortgages: Loans for purchasing real estate. 3. Corporate Bonds: Long-term bonds issued by corporations. Trends in the United States Over the years, there have been significant changes in the financial institutions landscape: 1. Decline of Depository Institutions: The share of commercial banks and thrifts has decreased since WWII. 2. Rise of Investment Companies and Pension Funds: These institutions now play a more significant role in providing access to securities markets and managing savings. 3. Creation of Financial Services Holding Companies: The Financial Services Modernization Act of 1999 allowed for the combination of banking, insurance, and investment activities within single entities, enhancing their service range and efficiency. Financial Crisis and Risk Management The financial crisis highlighted the need for effective risk measurement and management. The shift from the traditional "originate and hold" model to the "originate and distribute" model increased systemic risk. The crisis underscored the importance of enterprise risk management (ERM), which prioritizes managing risks as an interrelated portfolio and embedding risk management in all critical decisions. Fintech Financial technology (fintech) introduces innovative financial solutions, such as digital payments and cryptocurrencies, that challenge traditional financial methods. Fintech can disrupt traditional financial services but also offers opportunities for incumbents to streamline operations and reduce risks. Investing in fintech requires significant resources but can enhance efficiency and competitiveness in the financial services industry. GLOBALIZATION OF FINANCIAL MARKETS AND INSTITUTIONS LG 1-9 U.S. financial markets and institutions have counterparts globally, trading both domestic and foreign securities. While the U.S. has the largest markets, international markets have grown rapidly. For instance, in 2019, the UK issued 12.9% and the U.S. 9.6% of the world's debt securities. U.S. stock exchanges lead in equity markets, followed by Japan, Europe, and Hong Kong. The globalization of financial markets in the 1990s, fueled by technological advancements and demand for international diversification, significantly increased the volume of foreign securities traded. Growth in foreign financial markets is driven by several factors: increased savings pools in foreign countries, investors seeking better risk-return opportunities, accessible market information, U.S. financial institutions offering international investment opportunities, the euro's impact, growth in Pacific Basin and emerging markets, and deregulation in many countries. These factors have boosted foreign investment in U.S. markets, which grew from $989.3 billion in 1992 to $12,224.1 billion in 2019. U.S. financial markets' growth increasingly depends on global economic development, with U.S. financial institutions competing with international ones. In 2019, only 2 of the world's 10 largest banks by assets were U.S. banks. Globalization means U.S. market movements greatly impact foreign markets and vice versa. For example, U.S. credit market problems in 2007 triggered global market selloffs. Conversely, concerns over China's economic slowdown in 2015 and the UK's Brexit vote in 2016 had significant effects on U.S. markets. The trade war between the U.S. and China in the late 2010s also caused global market turbulence. APPENDIX 1A: The Financial Crisis: The Failure of Financial Institutions’ Specialness In the late 2000s, the world faced its worst financial crisis since the 1930s. By March 2009, the DJIA had fallen by 53.8% in less than 18 months. Home foreclosures hit record highs, and major financial institutions like AIG, Citigroup, and the big three automakers needed federal bailouts. The unemployment rate surpassed 10% by October 2009. This crisis significantly altered financial markets and institutions. The Beginning of the Collapse The crisis began in late 2006 when home prices dropped and subprime mortgage defaults surged. By mid-2007, foreclosure filings had increased dramatically. Financial institutions holding mortgage-backed securities faced enormous losses. By 2007, Citigroup, Merrill Lynch, and others wrote off billions due to bad loans. The crisis led to significant write-downs and losses for major financial institutions globally. The Failure of Bear Stearns Investment banks, heavily invested in mortgage-backed securities, suffered massive losses. Bear Stearns, after significant losses, was sold to JPMorgan Chase in March 2008 for $2 per share, down from $30 three days prior. The Federal Reserve intervened by lending directly to investment banks and cutting interest rates sharply, expanding its role beyond traditional boundaries. The Crisis Hits September 2008 was pivotal: the U.S. government seized Fannie Mae and Freddie Mac, Lehman Brothers declared bankruptcy, and Merrill Lynch was bought by Bank of America. This led to a severe market drop, with the DJIA falling over 500 points. By mid-September, global markets were in turmoil, and money market mutual fund withdrawals skyrocketed. The Rescue Plan In response, the Federal Reserve and central banks invested $180 billion to unfreeze credit markets. The U.S. government passed a $700 billion rescue plan, the Troubled Asset Relief Program (TARP), to buy toxic mortgages and securities, stabilize financial institutions, and increase FDIC insurance. The Crisis Spreads Worldwide The crisis spread globally, leading to government interventions in Germany, the UK, Ireland, Iceland, and more. These actions aimed to stabilize financial systems and protect consumer deposits. After the Rescue Plan Despite the TARP rescue, the crisis deepened. By mid-October, global stock markets had fallen sharply. The U.S. GDP dropped significantly, and countries worldwide faced economic downturns. By November 2008, Citigroup needed a massive government guarantee and cash injection to avoid failure. The U.S. Stimulus Plan President Obama enacted the American Recovery and Reinvestment Act in February 2009, focusing on infrastructure, direct spending, and tax breaks to stimulate the economy. The plan aimed to stabilize financial institutions and promote economic recovery. Financial Rescue Plan In early 2009, the Obama administration announced further measures to stabilize the financial system, including capital injections into banks, federal insurance against losses, and expanded loan facilities. Stress tests on major banks revealed a need for additional capital, which was raised swiftly. The Economy Begins to Recover By mid-2009, the economy showed signs of recovery. Home sales and construction increased, aided by tax credits and government programs. The DJIA rose to 10,000 by October 2009, though unemployment remained high. The Crisis Continues in 2009 Despite government efforts, the recession persisted. The DJIA and S&P 500 had their worst January ever, and unemployment soared. President Obama’s stimulus plan and financial rescue initiatives aimed to combat the downturn and restore confidence in the financial system. Some Bright Spots Amid the crisis, some positive developments occurred. Oil and gas prices fell, mortgage rates dropped, and efforts to restructure delinquent loans increased. The Fed's measures led to lower interest rates globally, aiding economic stabilization. Wall Street Reform and Consumer Protection Act In July 2010, the U.S. Congress passed the Wall Street Reform and Consumer Protection Act, aiming to prevent future financial crises. The Act strengthened regulation, promoted consumer protection, and established new oversight powers for the Federal Reserve. Key objectives included robust supervision of financial firms, comprehensive market regulation, consumer protection, crisis management tools, and improved international regulatory standards. 1 CAPITOLO MONEY MARKET Money Markets: Overview Money markets involve short-term debt instruments (maturing in one year or less) issued by entities needing short-term funds and purchased by those with excess funds. These instruments trade in active secondary markets, reallocating liquid funds efficiently. Unlike capital markets, which cater to long-term investment needs, money markets address short-term liquidity requirements for various participants. The 2008-2009 financial crisis highlighted the critical role of money markets, as the market froze, spiking the LIBOR and shrinking commercial paper markets, impacting daily operations. This chapter covers money market instruments, their issuance, trading processes, participants, and international money markets, especially Euro markets. Need for Money Markets Money markets exist because immediate cash needs of individuals, corporations, and governments often do not align with their cash receipts. For instance, the federal government collects taxes quarterly but incurs daily expenses. Similarly, corporations have mismatched cash inflows and outflows. Holding excess cash incurs an opportunity cost, so entities invest surplus cash in liquid financial securities that can be quickly converted back to cash with minimal risk. Money markets enable the quick, low-cost transfer of large amounts of money between fund suppliers and users for short periods. Characteristics of Money Markets and Instruments Money market securities have three main characteristics: 1. Large Denominations: Typically issued in units of $1 million to $10 million, catering to large transactions and keeping transaction costs low. Individual investors usually access these markets through financial institutions like money market mutual funds. 2. Low Default Risk: Issued by high-quality borrowers to ensure the quick return of cash with minimal default risk. 3. Short Maturity: Instruments have a maturity of one year or less, reducing interest rate risk over the Federal Reserve's Fedwire system. Trades can be directly negotiated or arranged through brokers. Banks with excess reserves lend to those with deficient reserves, often using oral agreements for overnight loans. Repurchase Agreements A repurchase agreement (repo) is a short-term, collateralized loan where one party sells securities with a promise to repurchase them at a specified date and price. Most repos are backed by U.S. Treasury or government agency securities and involve a "haircut" to protect the buyer against value changes. Repos can be overnight or have longer terms, with one-day to 14-day repos being most common. Reverse repos are the lender's position in the transaction. Trading Process Repos can be arranged directly or through brokers. For instance, JPMorgan Chase might purchase $75 million in Treasury bonds from Bank of America with an agreement to sell them back the next day. The transaction uses the Fedwire system to transfer funds and securities. Repurchase Agreement Yields Repo yields are low due to collateral backing, calculated as the annualized percentage difference between the selling and repurchase prices over a 360-day year. In 2019, outstanding fed funds and repos exceeded $4.1 trillion. Repos, while similar to fed funds, are less liquid and often used by nonbank entities. This streamlined summary maintains key details while reducing the original text by approximately 25%. Commercial Paper Commercial paper is an unsecured short-term promissory note issued by corporations to raise cash, often for working capital. With nearly $1.1 trillion outstanding as of December 2019, it is a significant money market instrument. Companies with strong credit ratings favor commercial paper due to lower interest rates compared to bank loans. Denominations range from $100,000 to $1 million, with maturities from 1 to 270 days. The SEC's rule requiring registration for securities with maturities over 270 days often leads to commercial paper being rolled over into new issues at maturity. Commercial paper can be sold directly to buyers or through dealers. It is typically held until maturity, meaning there's no active secondary market. Credit ratings by agencies like Standard & Poor's and Moody's are crucial for marketability. Lower-rated issuers may back their paper with a letter of credit from a bank, substituting the bank's credit rating for their own, reducing interest rates. In the early 2000s, downgrades of major issuers like General Motors and Ford impacted the commercial paper market, pushing these companies to long-term debt markets. The rise of asset- backed commercial paper (ABCP) in the mid-2000s peaked at $1.19 trillion in July 2007 but fell significantly during the financial crisis due to poor performance of mortgage-backed securities used as collateral. By November 2019, only $242 billion of ABCP remained. The financial crisis of 2008 led to significant withdrawals from money market mutual funds, shrinking the commercial paper market by $52.1 billion in one week. The Federal Reserve introduced the Commercial Paper Funding Facility (CPFF) to stabilize the market by purchasing commercial paper. Despite these measures, the market's total outstanding value continued to decline post-crisis, reaching $0.99 trillion in July 2013, and $1.1 trillion by December 2019. Trading Process Commercial paper can be sold directly by issuers or through dealers. Direct sales, around 10% of the market in 2019, save on dealer fees but require issuers to manage sales and discount rates themselves. Dealer placements, while more costly, offer underwriting guarantees and assistance in finding buyers. Dealers determine discount rates based on investor demand and help complete transactions promptly. Credit Ratings and Costs The interest rate on commercial paper depends on its credit rating. Higher-rated (Tier 1) issues have lower interest rates compared to lower-rated (Tier 2) issues. The spread between these rates widened significantly during the financial crisis, reflecting both default concerns and liquidity issues. The Federal Reserve's interventions helped reduce commercial paper rates, but the market has not fully recovered to pre-crisis levels. Negotiable Certificates of Deposit A negotiable certificate of deposit (CD) is a bank-issued time deposit with a specified interest rate and maturity date, and it can be sold in secondary markets. As of 2016, over $1.86 trillion in negotiable CDs were outstanding. These CDs are bearer instruments, meaning whoever holds the CD at maturity receives the principal and interest. Denominations range from $100,000 to $10 million, with $1 million being the most common. While negotiable CDs are too large for most individual investors, they are often purchased by money market mutual funds. Maturities range from two weeks to one year, typically one to four months. The first negotiable CD was issued in 1961 by First National City Bank of New York, which helped banks regain lost deposits due to rising interest rates in the 1950s. Trading Process for Negotiable CDs Banks issuing negotiable CDs post daily rates for popular maturities. Banks aim to sell CDs to investors who will hold them rather than resell them. Rates, maturities, and sizes of CDs can be directly negotiated between the bank and the investor. The bank delivers the CD to a custodian bank, which verifies it and transfers funds via the Fedwire system. The secondary market for negotiable CDs, though not very active, involves about 15 brokers and dealers, primarily located in New York City. Transactions are similar to those in the primary market and are settled on the same or next business day. Negotiable CD Yields Negotiable CD rates are negotiated and generally quoted using a 360-day year. Large, well-known banks can offer slightly lower rates due to perceived lower default risk and greater marketability. These CDs are single-payment securities. Banker’s Acceptances A banker’s acceptance is a time draft guaranteed by a bank, payable to a seller of goods. They are now included in commercial paper levels since June 2002. Banker’s acceptances are primarily used in international trade transactions, where banks guarantee payment to foreign exporters on behalf of domestic importers. Once accepted by the bank, these drafts can be held or sold at a discount in secondary markets. Maturities range from 30 to 270 days, with denominations determined by the original transaction size. Large banks dominate this market, and the low default risk is due to double protection from the importer and the bank. Comparison of Money Market Securities Money market securities share common characteristics: large denominations, low default risk, and short maturities. However, their liquidity varies. Treasury bills have an extensive secondary market, making them highly liquid. Commercial paper has no organized secondary market, making it harder to convert to cash quickly. Federal funds, being overnight transactions, have no secondary market. Negotiable CDs and banker’s acceptances can be traded in secondary markets but are often held by money market mutual funds. Money Market Participants The major participants in the money market include the U.S. Treasury, the Federal Reserve, commercial banks, money market mutual funds, brokers and dealers, corporations, other financial institutions, and individuals. U.S. Treasury: Issues Treasury bills (T-bills) to raise funds for short-term needs, making them the most actively traded money market securities. Federal Reserve: Uses T-bills, repurchase agreements, and reverse repos to manage the money supply and interest rates. It also targets the federal funds rate as part of its monetary policy and operates the discount window to influence bank reserves. Commercial Banks: Participate as issuers and investors in various money market instruments such as negotiable CDs, banker’s acceptances, federal funds, and repurchase agreements. Banks use these instruments to manage reserve requirements and liquidity. Money Market Mutual Funds: Invest in large amounts of money market securities and sell shares based on the value of these securities. In October 2019, they held $3.96 trillion in short-term financial securities, providing an alternative to bank deposits for small investors. Brokers and Dealers: Include primary government securities dealers who market new issues of T- bills and make secondary markets. Money and security brokers link buyers and sellers in the fed funds market and other money markets. They also assist smaller investors who can't access primary issues directly. Corporations: Issue commercial paper to raise short-term funds and invest excess cash in money market securities like T-bills, repos, and negotiable CDs to manage liquidity. Other Financial Institutions: Insurance companies, particularly property-casualty insurers, invest heavily in liquid money market securities due to their unpredictable liability payments. Finance companies, which cannot issue deposits, raise funds through commercial paper. Individuals: Participate through direct investments in money market securities or indirectly via money market mutual funds, which pool a mix of various money market instruments. International Aspects of Money Markets LG 5-5 Growth of Global Money Markets While the U.S. money markets are the largest and most active globally, international money markets have been expanding significantly. This growth is evident in two main forms: U.S. money market securities traded by foreign investors and foreign money market securities. Increased cross- border fund flows reflect international investors' pursuit of the most attractive yields. Foreign investments in U.S. money market securities rose from 1994 to 2007 but shifted during the financial crisis, with significant investments in U.S. Treasury securities. By the mid-2010s, investments in negotiable CDs surpassed pre-crisis levels. mitigate information costs by evaluating the creditworthiness of issuers. Municipal bonds serve as a crucial tool for state and local governments to fund various projects, offering tax-exempt interest to investors while being backed by tax revenues or project-specific revenues. Despite their benefits, they carry risks, including default risk, particularly during economic downturns. Corporate Bonds Corporate bonds, with $9.2 trillion outstanding in 2018, are long-term debt instruments issued by corporations. These bonds typically have a minimum denomination of $1,000 and pay semiannual interest. The bond indenture, a legal contract, outlines the rights and obligations of both the issuer and bondholders, including covenants that can either grant rights or impose restrictions on the issuer. Bond Characteristics • Bearer vs. Registered Bonds: Bearer bonds have physical coupons attached, while registered bonds have ownership recorded electronically. • Term vs. Serial Bonds: Term bonds mature on a single date, while serial bonds mature in installments over multiple dates. • Types of Bonds: These include mortgage bonds (secured by specific assets), equipment trust certificates (secured by movable property), debentures (unsecured), and subordinated debentures (junior unsecured debt). • Convertible Bonds: Can be exchanged for the issuer's stock at the bondholder's discretion. • Stock Warrants: Allow bondholders to purchase stock at a specified price without surrendering the bond. • Callable Bonds: Can be repurchased by the issuer before maturity at a specified price, usually when interest rates drop. • Sinking Fund Provisions: Require the issuer to retire a portion of the bond issue periodically, reducing default risk at maturity. Trading Process Primary sales of corporate bonds occur through public sales or private placements. Secondary trading happens on exchange markets (like NYSE Bonds) and over-the-counter (OTC) markets. Most trading volume occurs OTC, even for exchange-listed bonds, contributing to liquidity risk in corporate bond trading. Bond Ratings and Interest Rate Spreads Bond ratings by agencies like Moody’s, Standard & Poor’s (S&P), and Fitch assess default risk. Ratings range from AAA (highest quality) to lower grades, influencing the interest spread over similar maturity Treasury securities. Spreads incorporate not only default risk but also liquidity risk and special bond provisions, offering a comprehensive risk measure. Rating Agencies and Criticisms Rating agencies analyze the issuer’s financial health, market position, and specific bond issue characteristics. However, they have faced criticism for slow reactions and conflicts of interest, notably during the Enron scandal and the financial crisis of 2008-2009. Legislative reforms, such as the Wall Street Reform and Consumer Protection Act, have sought to address these issues by allowing lawsuits against rating agencies for negligence and establishing oversight. Interest Rate Spreads and Market Trends Interest rate spreads, the difference between corporate bond yields and Treasury yields, reflect the overall risk of corporate bonds. Spreads widened significantly during the financial crisis due to increased default and liquidity risks, as investors sought safer Treasury securities. The spread on Aaa-rated bonds averaged 1.24% and on Baa-rated bonds 2.32% from 1980 to 2019, with peaks during economic downturns. Corporate bonds provide essential financing for corporations but come with varying levels of risk and investor protections. Understanding the characteristics, trading processes, and rating mechanisms is crucial for investors navigating the corporate bond market. Bond Market Indexes and Participants Bond Market Indexes Bond market indexes provide investors with general information on returns from bonds of various issuers and maturities. Table 6-11, as of January 17, 2020, lists major bond market indexes managed by investment banks like Barclays. These indexes reflect both monthly capital gains/losses and interest (coupon) income earned. Changes in these indexes help bond traders evaluate the investment attractiveness of different types and maturities of bonds. Bond Market Participants Bond markets facilitate the interaction between suppliers and demanders of long-term funds. The major issuers of debt market securities include federal, state, and local governments, as well as corporations. The major purchasers are households, businesses, government units, and foreign investors. Major Issuers and Purchasers • Governments: Issue Treasury securities and municipal bonds. • Corporations: Issue corporate bonds. • Households: Often purchase bonds indirectly through financial firms like mutual funds and pension funds. • Foreign Investors: Hold significant portions of U.S. Treasury securities, influencing the U.S. economy. For instance, China’s holdings of U.S. Treasury securities increased from $388 billion in 2007 to $1.32 trillion by 2013. Japan reclaimed its position as the largest investor in mid-2015 due to higher yields offered by U.S. debt relative to other countries. However, by late 2015, both China and Japan began selling U.S. Treasuries to support their own currencies amid global economic instability. Holdings by Financial Firms Figure 6-10 shows the percentage of each bond type held by major groups, highlighting that financial firms (e.g., banks, insurance companies, mutual funds) are the major holders of Treasury, municipal, and corporate bonds: • Treasury Securities: 36.65% • Municipal Bonds: 51.77% • Corporate Bonds: 61.53% These holdings reflect not only direct investments but also indirect investments by households through financial firms. Comparison of Bond Market Securities Figure 6-11 shows the yield to maturity on various types of bonds (e.g., 10-year Treasury bonds, municipal bonds, high-grade corporate bonds) from 1980 to 2019. Yield changes are highly correlated, but yield spreads vary due to differences in default risk, tax status, and marketability. • Default Risk: Higher default risk leads to higher yield spreads. • Tax Status: Tax-exempt status of municipal bonds makes them attractive to investors in higher tax brackets. • Marketability: More marketable bonds typically have lower yield spreads. Economic Conditions and Yield Spreads Economic conditions significantly influence bond yield spreads. During periods of slow economic growth (e.g., 1982, 1989-1991, 2008-2019), investors demand higher default risk premiums, leading to wider yield spreads. The St. Louis Federal Reserve Bank and Bloomberg provide free online access to U.S. economic and financial data, including daily interest rates, monetary indicators, exchange rates, balance of payments, and bond yields, helping investors track and analyze market trends. International Aspects of Bond Markets Definition and Importance International bond markets trade bonds underwritten by an international syndicate, offered to investors in different countries, and issued outside the jurisdiction of any single country. These bonds are often unregistered. For investors, adding international bonds to a fixed-income portfolio can diversify risk, particularly since international sovereign bonds often exhibit low correlation with U.S. and international stocks during extreme market stress. However, foreign turmoil and currency exchange rate changes can impact the returns and attractiveness of international bonds. Benefits and Risks for Bond Issuers For issuers, international bond markets provide additional financing options and motivate domestic markets to improve infrastructure, investor protection, and reduce tax distortions. However, these placements can increase risk by causing sudden shifts in capital flows, concentrating liquidity offshore, and limiting the development of domestic markets and availability of collateral for domestic markets. International Debt Statistics Table 6-12 lists the values of international debt outstanding by currency and type from 1995 through 2018. At the end of 2018, international debt securities totaled $24.22 trillion, up from $3.07 trillion in 1996. Fixed-rate securities dominate the market due to strong demand for dollar and euro assets and low interest rates in developed countries. Floating-rate notes are also significant due to interest rate uncertainties in the late 1990s and 2000s. Currency Denomination Trends A majority of international debt instruments are denominated in local currencies. In December 2018, 60.4% of general government debt securities were denominated in U.S. dollars. Fixed-rate securities are more common than floating-rate securities, ranging from 61.9% to 68.7% over the period 1996-2018. Types of International Bonds 1. Eurobonds: Issued outside the country of the currency in which they are denominated (e.g., dollar-denominated bonds issued in Europe or Asia). Eurobonds avoid taxes and regulations specific to domestic markets and are usually issued in denominations of $5,000 or $10,000. They pay interest annually using a 360-day year and are typically bearer bonds traded OTC, mainly in London and Luxembourg. 2. Foreign Bonds: Issued by foreign entities in the domestic market of another country and denominated in that country's currency (e.g., Yankee bonds in the U.S., Samurai bonds in Japan). Reverse Yankee bonds are bonds issued in foreign currencies by U.S. companies relationships between countries. Residual Claim Common stockholders have the lowest priority claim on a corporation’s assets in the event of bankruptcy—they have a residual claim. This means that only after all senior claims are paid (i.e., payments owed to creditors such as the firm’s employees, bondholders, the government for taxes, and preferred stockholders) are common stockholders entitled to any remaining assets of the firm. For instance, during the Lehman Brothers bankruptcy in 2008, shareholders were left with nothing. This residual claim characteristic makes common stock a riskier investment compared to bonds. Limited Liability One of the most crucial features of common stock is its limited liability. Limited liability means that common stockholders' losses are limited to the amount of their original investment in the firm. If the company's asset value falls below its debt value, common stockholders do not have to use their personal assets to cover the firm's debts. This protection is in contrast to sole proprietorships or partnerships, where owners might be liable for the firm’s debts beyond their initial investment, risking their personal wealth. Voting Rights Common stockholders possess voting rights, which allow them to influence the firm's activities indirectly through the election of the board of directors. The board oversees the company's operations and is responsible for ensuring that the firm maximizes its value. Shareholders also vote on significant issues such as mergers and dividend changes. For example, in February 2016, Alere's shareholders were involved in a lawsuit delaying a $5.8 billion acquisition by Abbott due to alleged financial reporting issues. Typically, stockholders have one vote per share, but some companies have dual-class shares with different voting rights. Dual-Class Firms Dual-class firms have two classes of common stock with differing voting and/or dividend rights. This structure is often used by family-controlled firms to retain control while raising capital. For example, Berkshire Hathaway’s Class B shares have limited voting rights compared to Class A shares. Such structures can be controversial as they might entrench a small group of insiders. Voting Methods Two primary methods for electing a board of directors are cumulative voting and straight voting. Cumulative voting allows shareholders to allocate all their votes to one candidate or spread them among several candidates, benefiting minority shareholders. Straight voting elects one director at a time, with each share typically having one vote per director, favoring majority shareholders. Proxy Votes Many shareholders vote by proxy, allowing them to vote without attending the annual meeting. Proxies are mailed to shareholders, who can return them to authorize representatives to vote on their behalf. Internet voting is also becoming more common, increasing shareholder participation. Preferred Stock Preferred stock is a hybrid security that combines features of both bonds and common stock. It provides an ownership interest in the firm like common stock but pays fixed dividends like bonds. Preferred stock is senior to common stock but junior to bonds in terms of claims on assets and earnings. Dividends on preferred stock are usually fixed and paid before common stock dividends but can be missed without causing bankruptcy. However, missed dividends must be paid before any common stock dividends in cumulative preferred stock arrangements. Characteristics of Preferred Stock 1. Dividends: Preferred stock pays fixed dividends, often quarterly. These dividends are not tax-deductible for the issuing corporation, making preferred stock more expensive than bonds. 2. Nonparticipating vs. Participating: Nonparticipating preferred stock pays a fixed dividend regardless of the firm's profits. Participating preferred stock can pay additional dividends if the firm performs well. 3. Cumulative vs. Noncumulative: Cumulative preferred stock requires that any missed dividends be paid before common dividends. Noncumulative preferred stock does not accrue missed dividends. 4. Voting Rights: Typically, preferred stockholders do not have voting rights unless dividends are missed. In some cases, preferred stock can be converted into common stock at the holder's discretion. 5. Conversion: Many preferred stocks can be converted into common stock at a predetermined rate, providing potential for capital appreciation. Benefits and Drawbacks of Preferred Stock Preferred stock provides flexibility for corporations as missed dividend payments do not lead to bankruptcy. It can also be attractive to investors seeking steady income with priority over common stock dividends. However, the cost of issuing preferred stock is generally higher than bonds due to non-deductible dividends, and missed dividends can hinder a corporation's ability to raise new capital. PRIMARY AND SECONDARY STOCK MARKETS Primary Stock Markets Primary stock markets are where corporations raise funds by issuing new stocks to investors. This process involves investment banks, which act as intermediaries between the corporation (issuer) and the investors (fund suppliers). Here, the investment bank facilitates the sale of new stocks through underwriting, ensuring that the corporation receives the funds needed for its operations, expansions, or other financial needs. Underwriting Methods 1. Firm Commitment Underwriting: In a firm commitment underwriting, the investment bank buys the entire stock issue from the corporation at a guaranteed price, called the net proceeds. The bank then resells the stock to investors at a higher price, known as the gross proceeds. The difference between these two prices is the underwriter’s spread, which compensates the investment bank for its expenses and the risk it undertakes by guaranteeing the sale. If the bank cannot sell the stock at the expected price, it must still purchase all unsold shares, bearing the financial risk. 2. Best Efforts Underwriting: In a best efforts underwriting, the investment bank does not guarantee a sale price to the issuer. Instead, it acts as a distribution agent, attempting to sell the stock at the best possible price for a fee. The risk is lower for the investment bank because it does not have to purchase unsold shares, but the issuing corporation does not receive a guaranteed amount of funds. Syndication Often, an investment bank will form a syndicate with other investment banks to spread the risk and ensure a broader distribution of the new stock issue. A syndicate involves multiple banks, each responsible for selling a portion of the shares. This collaboration helps mitigate the risk associated with the sale and increases the chances of a successful issuance. Types of Primary Market Sales 1. Initial Public Offerings (IPOs): An IPO is the first-time issuance of stock by a private company going public. This allows the company’s equity, previously held privately by managers and venture capital investors, to be publicly traded in stock markets for the first time. The IPO process often attracts significant attention as it marks the company’s debut on the public market. 2. Seasoned Offerings: A seasoned offering, or follow-on offering, involves a company that already has publicly traded shares issuing additional stock. This allows the company to raise more funds from investors without the extensive scrutiny of an IPO. Preemptive Rights In some states, corporate law and certain corporate charters grant existing shareholders preemptive rights. This means that before a seasoned offering can be sold to new investors, existing shareholders must be given the opportunity to purchase new shares to maintain their proportional ownership in the corporation. This is typically done through a rights offering, where shareholders can buy additional shares at a discount to the market price. Example of Rights Offering Calculation: Suppose you own 1,000 shares of a company with 1 million total shares outstanding. The company announces a rights offering to issue 500,000 new shares. Each shareholder will receive 0.5 rights per share owned. With each right allowing the purchase of one new share, you can buy 500 additional shares to maintain your ownership percentage. If the market price is $40 per share and the rights offer the new shares at $36 each, the company's value after the rights offering is $58 million ($40 million original value + $18 million from new shares). The new per-share value is $38.67 ($58 million ÷ 1.5 million shares). If you exercise your rights, your 1,500 shares are worth $58,000 ($38.67 per share). Registration In a public stock sale, the issuing firm and investment bank must register with the Securities and Exchange Commission (SEC) according to the Securities and Exchange Act of 1934. The registration process ensures transparency and protects investors by providing full disclosure about the firm and the securities being issued. 1. Registration Statement: The registration statement includes details about the issuer’s business, key features of the security, associated risks, and background on management. This document is crucial for transparency and investor protection. 2. Red Herring Prospectus: A preliminary version of the public offering’s prospectus, the red herring prospectus, is distributed to potential buyers. It is similar to the registration statement but specifically designed to inform investors about the upcoming stock issue. Feedback from this document helps set the final price for the new shares. NYSE Composite Index Established in 1966, the NYSE Composite Index provides a comprehensive measure of the performance of all common stocks listed on the New York Stock Exchange (NYSE). Characteristics of the NYSE Composite Index: • Value-Weighted Index: The index is calculated by adding the current market values of all stocks in the index and dividing by their value on a base date. • Subgroups: The NYSE Composite Index is divided into four subgroups: industrial, transportation, utility, and financial companies. • Base Value Adjustment: In January 2003, the composite index was recalculated to reflect a new base value of 5,000, modernizing its methodology. Standard & Poor’s 500 Index (S&P 500) The S&P 500 Index, established by Standard & Poor’s, consists of the top 500 largest U.S. corporations listed on the NYSE and NASDAQ. Characteristics of the S&P 500: • Value-Weighted Index: This index includes stocks based on their market capitalization, reflecting the overall market performance. • Broad Representation: The index accounts for over 80% of the total market value of all NYSE stocks, making it highly representative of the overall stock market. • Subindexes: It includes subindexes for industrials and utilities. Historical Performance: Movements in the S&P 500 are highly correlated with the NYSE Composite Index, with a correlation of 0.97 from 1989 through December 2019. The index experienced significant losses during the financial crisis of 2008-2009 but recovered in the subsequent years, paralleling the recovery trends seen in other major indexes. NASDAQ Composite Index The NASDAQ Composite Index, established in 1971, includes all stocks traded on the NASDAQ, focusing on industries like technology, banking, and insurance. Characteristics of the NASDAQ Composite Index: • Value-Weighted Index: It includes all stocks traded on the NASDAQ, with subindexes for industrials, banks, insurance companies, computers, and telecommunications. • Tech-Heavy: The index is heavily weighted towards technology companies, making it a key indicator of the tech sector's performance. Wilshire 5000 Index The Wilshire 5000 Index, created in 1974, aims to track the value of the entire U.S. stock market. Characteristics of the Wilshire 5000: • Broadest Stock Market Index: It includes virtually every stock that meets specific criteria, such as being headquartered in the U.S., actively traded, and having widely available price information. • Value-Weighted Index: Like the other major indexes, it is calculated based on the market capitalization of its components. • Current Composition: Although it started with 5,000 firms, it now includes 3,618 stocks due to delistings, privatizations, and acquisitions. Historical Performance: The Wilshire 5000 is considered the most accurate reflection of the overall stock market due to its comprehensive inclusion of public firms. However, its broad scope makes it challenging to determine specific sectors or asset classes driving market movements. Trends in Stock Market Indexes From 1989 through 2019, the DJIA, NYSE Composite Index, S&P 500, NASDAQ Composite Index, and Wilshire 5000 Index showed highly correlated movements. Significant events such as the financial crisis of 2008-2009 resulted in substantial losses across all indexes, with the DJIA, for example, dropping over 50%. However, recovery in the stock prices began in the latter half of 2009 and continued into the next decade, with indexes reaching new record highs by the end of 2019. Importance of Stock Market Indexes Stock market indexes are crucial for investors as they provide: • Market Sentiment: Indicating the overall performance and health of the stock market. • Benchmarking: Allowing investors to compare the performance of their portfolios against the market. • Economic Indicators: Reflecting broader economic trends and potential future economic activity. Stock Market Participants Overview Table 8-4 provides an insightful overview of the distribution of corporate stock holdings among different types of investors from 1994 through 2019. It highlights the dominance of households, mutual funds, and foreign investors in the stock market. Here's a detailed analysis of the key participants in the stock market and their impact on stock ownership trends. Major Holders of Corporate Stock Households Households are the largest holders of corporate stock, owning 38.0% of all corporate stock outstanding in 2019. This dominance underscores the importance of individual investors in the equity markets. Households also invest indirectly in corporate stock through mutual funds and pension funds. When these indirect holdings are combined, households' total investment in the stock market is substantial. Mutual Funds Mutual funds are significant participants in the stock market, holding 23.5% of the total corporate stock outstanding in 2019. These funds pool resources from numerous investors, offering diversified portfolios and professional management. Mutual funds play a crucial role in providing liquidity and stability to the stock market. Foreign Investors Foreign investors, categorized as the "rest of the world," held 15.9% of the $47.5 trillion in corporate stock outstanding in 2019. This reflects the globalization of financial markets and the attractiveness of U.S. equities to international investors. The presence of foreign investors adds depth and liquidity to the market, although it also introduces elements of currency and geopolitical risk. Impact of the Financial Crisis The financial crisis of 2008-2009 had a profound impact on stock ownership across various groups. The crisis led to a general decline in stock prices and a shift towards safer investments. Here's a breakdown of the changes in stock holdings before and after the crisis: • Households: Stock holdings dropped by 21.9%. • Private Pension Funds: Declined by 32.2%. • Public Pension Funds: Fell by 19.1%. • Mutual Funds: Decreased by 18.0%. • Closed-End Funds: Dropped by 38.0%. • Brokers and Dealers: Decreased by 50.0%. These declines illustrate the flight to safety during periods of economic uncertainty and the subsequent recovery as markets stabilized. Trends in Stock Market Participation Ownership Rates Figure 8-14 shows the percentage of Americans with investments in the stock market from 1998 through 2019. Stock ownership peaked at 65% in 2007 before plummeting during the financial crisis. Despite a recovery in stock prices from 2010 to 2019, individual participation did not fully rebound, reaching a low of 52% in 2013 and 2016. By 2019, participation began to pick up slightly as the economy improved and unemployment rates decreased. Demographic Breakdown Table 8-5 provides a detailed analysis of stock ownership by income and age: • Income: Stock ownership rates are highly correlated with income levels. Ownership ranges from 21% among those with annual household incomes of less than $30,000 to 89% among those with incomes of $100,000 or more. • Age: Middle-aged Americans (30 to 64 years) are the most likely to own stocks (62% on average). Younger adults (18 to 29 years) have a 31% ownership rate, while those aged 65 and older have a 54% ownership rate. Stock Market and Economic Activity The present value of a stock is determined by the discounted sum of expected future dividends. Changes in expected future dividends directly affect stock prices. Consequently, stock market indexes can serve as indicators of future economic activity. An increase in stock market indexes suggests expectations of higher corporate profits and economic growth, while a decrease signals the industry’s over $606.2 billion new life insurance premiums in 2018. Although not to the extent seen in the banking industry, the life insurance industry has experienced major mergers in recent years as competition within the industry and with other FIs has increased. Like consolidation in commercial banking, the consolidation of the insurance industry has mainly occurred to take advantage of economies of scale and scope and other synergies. Life insurance allows individuals to protect themselves and their beneficiaries against the risk of loss of income in the event of death or retirement. By pooling the risks of individual customers, life insurance companies can diversify away some of the customer-specific risk and offer insurance services at a cost (premium) lower than any individual could achieve saving funds on his or her own. Thus, life insurance companies transfer income-related uncertainties such as those due to retirement from the individual to a group. Although life insurance may be their core activity area, modern life insurance companies also sell annuity contracts, manage pension plans, and provide accident and health insurance. Figure 15–1 shows the distribution of premiums written for the various lines of insurance in 2018. In return for insurance premiums, insurance companies accept or underwrite the risk that the prespecified event will occur. The major part of the insurance company underwriting process is deciding which requests for insurance (or risks) they should accept and which ones they should reject. For those risks they accept, they must decide how much they should charge for the insurance. One problem faced by life insurance companies (as well as property–casualty insurers) is the adverse selection problem. Adverse selection is the problem that customers who apply for insurance policies are more likely to be those most in need of insurance. Insurance companies deal with the adverse selection problem by establishing different pools of the population based on health and related characteristics. By altering the pool used to determine the probability of losses to a particular customer’s health characteristics, the insurance company can more accurately determine the probability of having to pay out on a policy and can adjust the insurance premium accordingly. Actuaries have traditionally worked in life insurance to reduce the risks associated with underwriting and selling life insurance. With traditional life insurance, actuarial science focuses on the analysis of mortality, the production of life tables, and the application of time value of money to produce life insurance, annuities, and endowment policies. In health insurance, actuarial science focuses on the analyses of rates of disability, morbidity, mortality, fertility, and other contingencies. Types of Life Insurance Policies The four basic classes or lines of life insurance are distinguished by the manner in which they are sold or marketed to purchasers: ordinary life, group life, credit life, and other activities. Of the $19.1 trillion life insurance policies in force in the United States, ordinary life accounts for 53.6 percent, group life for 45.6 percent, and credit life for less than 1 percent. 1. Ordinary Life: Marketed on an individual basis, usually in units of $1,000, with policyholders making periodic premium payments for coverage. There are five basic contractual types: term life, whole life, endowment life, variable life, and universal life. • Term Life: Closest to pure life insurance with no savings element. If the insured individual lives beyond the term, the contract expires with no benefits. • Whole Life: Protects the individual over an entire lifetime. Premiums create a cash value that can be borrowed against. • Endowment Life: Combines term insurance with a savings element, guaranteeing a payout if death occurs during the endowment period. • Variable Life: Premium payments are invested in mutual funds, and the policy's value varies with the asset returns. • Universal Life: Allows the insured to change premium amounts and contract maturity, with premiums often invested in mutual funds. 2. Group Life Insurance: Covers a large number of insured persons under a single policy, usually issued to corporate employers. It can be either contributory or noncontributory. 3. Credit Life Insurance: Protects lenders against a borrower’s death prior to the repayment of a debt contract. It represents less than 1 percent of the total market. 4. Other Life Insurer Activities: Includes the sale of annuities, private pension plans, and accident and health insurance. • Annuities: Represent the reverse of life insurance principles, liquidating a fund over time rather than paying out a lump sum. • Private Pension Funds: Insurance companies offer various pension plans to private employers, managing over $3.7 trillion in pension fund assets in 2018. • Accident and Health Insurance: Protects against morbidity or ill-health risk, with more than $185 billion in premiums written in 2018. LG 15-3 Balance Sheets and Recent Trends Assets Due to the long-term nature of their liabilities and the need to generate competitive returns on the savings elements of life insurance products, life insurance companies concentrate their asset investments at the longer end of the maturity spectrum. This includes corporate bonds, equities, and government securities. As shown in Table 15-2, in 2018, life insurance companies allocated their assets as follows: • Government securities: 6.8% • Corporate bonds and stocks: 63.5% • Mortgages (commercial and home): 8.1% Other loans, including policy loans (loans made to policyholders using their policies as collateral), and miscellaneous assets comprised the remaining assets. Insurance companies hold mortgages as investment securities, purchasing many in the secondary markets. Over the long term, there has been an increase in the proportion of bonds and equities and a decline in the proportion of mortgages on life insurers’ balance sheets. Consequently, insurance company managers must effectively measure and manage the credit risk, interest rate risk, and other risks associated with these securities. Liabilities Table 15-3 presents the aggregate balance sheet for the life insurance industry at the end of 2018. On the liability side, $5.4 trillion, or 76.9% of total liabilities and capital, reflect net policy reserves. These reserves are based on actuarial assumptions regarding an insurer’s expected future liability or commitment to pay out on present contracts, including death benefits, maturing endowment policies, and the cash surrender value of policies. Despite conservative actuarial assumptions, unexpected fluctuations in future payouts can occur, such as increases in mortality rates due to catastrophic events. To meet unexpected future losses, life insurers hold a capital and surplus reserve fund. In 2018, these reserves totaled $418.7 billion, or 6.0% of their total liabilities and capital. Separate account business, which was 35.6% of total (combined) liabilities and capital in 2018, involves funds invested and held separately from the insurance company’s other assets. These funds can be invested without usual restrictions, often in all stocks or all bonds. The return on life insurance policies written as part of separate account business depends on the return on the invested funds. Additionally, guaranteed investment contracts (GICs), representing 7.5% of total liabilities and capital, are short- and medium-term debt instruments sold by insurance companies to fund their pension plan business. Recent Trends Insurance companies earn profits by taking in more premium and interest income than they pay out in policy payments. Firms can increase their spread between premium income and policy payouts by either decreasing future required payouts for any given level of premium payments or increasing the profitability of interest income on net policy reserves. Since insurance liabilities are typically long-term, companies have extended periods to invest premium payments in interest-earning asset portfolios. Higher yields on these investments increase profitability. The life insurance industry was highly profitable in the early and mid-2000s, with over $500 billion in premiums and annuities recorded annually from 2004 to 2006, and net income topping $34 billion in 2006. However, the 2008–2009 financial crisis severely impacted the industry. The value of stocks and bonds in insurers' asset portfolios dropped, and losses were experienced in commercial mortgage-backed securities, commercial loans, and lower-grade corporate debt as bond default rates increased and mortgage markets froze. The reduced value of equity market assets also decreased asset-based fees earned from balances on equity-linked products, such as variable annuities. As investors sought the safety of government bonds during the financial crisis, the yields on these bonds fell, reducing a significant source of investment income for life insurers. The industry faced huge losses in 2008, with realized and unrealized capital losses from bonds, preferred stocks, and common stocks exceeding $35 billion. Net investment income also fell by 3.5% from 2007, resulting in a net after-tax income of -$51.8 billion in 2008, an $83.7 billion decrease from 2007. In late 2008 and early 2009, insurance company reserves began to dwindle to dangerous levels. The falling value of their assets made it difficult for insurers to raise capital, prompting the Treasury Department to extend bailout funds to several struggling life insurance companies, including $127 billion to AIG. Other insurers receiving Troubled Asset Relief Program (TARP) funds included Hartford Financial Services Group, Prudential Financial, Lincoln National, and Allstate. The impact of the financial crisis continued to be felt in 2009, with premium income falling by $120 billion (19%) from 2008 levels, and net realized capital for the industry falling by $28.7 billion. However, by late 2009, the industry saw some improvements, with an increase in total assets and net income returning to a positive $21.1 billion. Premiums continued to recover from 2010 through 2018, with 2012 premiums surpassing pre-crisis levels and further increasing to $747.9 billion by 2018. Net income also increased to $28.0 billion in 2010 and $48.7 billion in 2018. However, challenges remain, including historically low interest rates, volatile equity markets, and new regulations that could affect profits. Regulation The McCarran–Ferguson Act of 1945 confirms the primacy of state over federal regulation of insurance companies, meaning that a life insurer is chartered entirely at the state level. State insurance commissions supervise and examine insurance companies using a coordinated examination system developed by the National Association of Insurance Commissioners (NAIC). Regulations cover areas such as insurance premiums, insurer licensing, sales practices, commission charges, and the types of assets in which insurers may invest. In response to the financial crisis, the U.S. Congress considered establishing an optional federal insurance charter. The Wall Street Reform and Consumer Protection Act of 2010 established the Federal Insurance Office (FIO), which monitors the insurance industry, identifies regulatory gaps or systemic risks, and deals with international insurance matters. The Act also established the Financial Stability Oversight Council (FSOC) to identify financial institutions presenting systemic Regulation Similar to life insurance companies, property–casualty (P&C) insurers are chartered and regulated at the state level by state commissions. State guarantee funds provide protection to policyholders in case a P&C insurance company fails, similar to the protection described for life insurance companies. The National Association of Insurance Commissioners (NAIC) offers various services to state regulatory commissions, including a standardized examination system and the Insurance Regulatory Information System (IRIS). IRIS identifies insurers operating outside normal ranges in terms of loss, combined, and other ratios. P&C insurers face additional burdens in some lines of activity, especially auto insurance and workers’ compensation insurance, due to rate regulation. Given the social welfare importance of these lines, state commissioners often set ceilings on premiums and premium increases, usually based on specific formulas for cost of capital and line risk exposure. This regulation has led some insurers to leave states with restrictive regulations, such as New Jersey, Florida, and California. In recent years, the P&C industry has faced scrutiny for its handling of claims from homeowners associated with Hurricane Katrina. Homeowners’ policies excluded flood damage, and insurers argued that the storm surge from Hurricane Katrina was classified as flood damage, thus excluded from coverage. Policyholders, however, contended that the storm surge was a direct result of hurricane winds, a covered risk, and claimed insurers used deceptive practices to sell hurricane policies while collecting extra premiums. A 2007 verdict held State Farm responsible for policy limits totaling more than $220,000 on a loss deemed to be due to storm surge flooding and also held the company liable for punitive damages. Global Issues The insurance sector, like other financial institution sectors, is becoming increasingly global. In 2018, the United States, Japan, and Western Europe dominated the global market, with all regions engaged in the insurance business and many insurers operating internationally. Table 15–7 lists the top 10 countries by total premiums written in 2018 and their percentage share of the world market. Table 15–8 lists the top 10 insurance companies worldwide by total revenues. Worldwide, 2017 was the costliest year for the insurance industry, with natural disasters costing insurers a record $138 billion in losses. North America accounted for 83% of the total losses. This surpassed the previous record of $119 billion in 2011, when earthquakes in Japan and New Zealand caused huge payouts. In 2017, total economic costs from natural disasters worldwide amounted to $340 billion, compared with $400 billion in 2011. Outside the United States, earthquakes in Italy in 2017 produced total insured losses of $1.6 billion, and flooding in China in July caused insured damage totaling $180 million. A key driver of losses in 2017 were hurricanes Harvey, Irma, and Maria, which struck the USA and Caribbean in quick succession. Unusual loss events also occurred, such as the 2016/2017 winter in Northern California, which brought excessive snow and rain. This led to abundant vegetation growth, providing fuel for wildfires that caused billions of dollars in losses later in the year. Comparing the last 30 years, 2018 was above the inflation-adjusted overall loss average of $140 billion. Insured losses in 2018 amounted to $80 billion, significantly higher than the 30-year average of $41 billion, making it one of the ten costliest disaster years. Hurricanes Michael and Florence in the Atlantic, and typhoons Jebi, Mangkhut, and Trami in Asia, contributed significantly to the losses. Tropical cyclones in 2018 resulted in overall losses of approximately $57 billion, with $29 billion insured. Wildfires in California produced overall losses of $24 billion and insured losses of $18 billion. Over the year, 29 events resulted in losses of $1 billion or more each. In 2018, roughly 50% of global macroeconomic losses from natural catastrophes were insured, a significantly higher percentage than the long-term average of 28%. North America accounted for 68% of insured losses, Asia for 23%, and Europe for 8%. The remaining losses were divided between South America, Africa, Australia, and Oceania. 6 CAPITOLO Securities Firms and Investment Banks Services Offered by Securities Firms Versus Investment Banks: Chapter Overview Securities firms and investment banks primarily facilitate the transfer of funds from net suppliers (e.g., households) to net users (e.g., businesses) at a low cost and with high efficiency. Unlike other financial institutions, such as banks, these firms do not transform the securities issued by net users into more attractive claims for net suppliers. Instead, they act as brokers, intermediating between fund suppliers and users. Investment Banking Investment banking involves various transactions, including the raising of debt and equity securities for corporations or governments. This process encompasses the origination, underwriting, and placement of securities in money and capital markets. Investment banks also engage in corporate finance activities such as advising on mergers and acquisitions (M&As) and the restructuring of existing corporations. Securities Services Securities services include assisting in the trading of securities in secondary markets, which involves brokerage services and market making. The largest firms in this industry perform multiple services, including underwriting and brokerage, and are generally referred to as investment banks. Other firms may specialize in one area, such as securities trading or underwriting, and are known as securities firms. Structural Changes and Consolidations The industry has experienced significant structural changes and consolidations. Notable events include the acquisition of Bear Stearns by JPMorgan Chase, the bankruptcy of Lehman Brothers, and the acquisition of Merrill Lynch by Bank of America. By the end of 2008, the financial crisis led to the disappearance or transformation of all but two of the largest investment banks (Goldman Sachs and Morgan Stanley), which converted to commercial bank holding companies. Size, Structure, and Composition of the Industry The size of the securities and investment banking industry is typically measured by the equity capital of firms rather than by asset size. This is because securities trading and underwriting require relatively little investment in assets or liability funding. Instead, these activities are profit- generating based on equity. Industry Growth and Concentration The number of firms in the industry expanded significantly from 1980 until the stock market crash of 1987, after which a major shakeout occurred. By 2006, the number of firms had declined, and concentration among the largest firms increased through mergers and acquisitions. Regulatory changes, such as the Financial Services Modernization Act of 1999, facilitated many interindustry mergers among financial service firms. Impact of the Financial Crisis The financial crisis resulted in the failure or transformation of the largest investment banks. By the end of 2008, Lehman Brothers had failed, Bear Stearns and Merrill Lynch were acquired, and Goldman Sachs and Morgan Stanley converted to commercial bank charters. This led to a significant change in the industry structure, with commercial bank holding companies' fee income from investment banking and related services increasing post-crisis. Classification of Firms in the Industry Firms in the industry can be divided into several categories based on the services they provide and the clients they serve: 1. National Full-Service Investment Banks: • These firms service both retail and corporate customers, offering a range of services including advice, underwriting, brokerage, trading, and asset management. • Subgroups include commercial bank or financial services holding companies (e.g., Bank of America, Morgan Stanley, JPMorgan), firms specializing in corporate finance and trading (e.g., Goldman Sachs), and large investment banks with institutional client bases (e.g., Lazard Ltd., Greenhill & Co.). 2. Regional Securities Firms: • These firms concentrate on servicing customers in specific regions (e.g., Raymond James Financial). 3. Specialized Discount Brokers: • These brokers, such as Charles Schwab, facilitate trades for customers without offering investment advice. 4. Specialized Electronic Trading Firms: • Firms like E*Trade provide online trading platforms, allowing customers to trade securities via the internet. 5. Venture Capital and Private Equity Firms: • These firms pool funds from investors to finance small and new businesses (e.g., in biotechnology). 6. Other Firms: • This category includes research boutiques, firms with large clearing operations, and designated market makers like GTS, Virtu Financial, and Citadel Securities. Recent Trends and Regulation The industry has seen continued consolidation and regulatory changes. Firms must navigate complex regulations while adapting to technological advancements and market conditions. The shift toward electronic trading and the rise of fintech innovations are also reshaping the industry landscape. Securities Firm and Investment Bank Activity Areas Securities firms and investment banks engage in several key activities that serve different aspects of the financial markets. These activities include investment banking, venture capital, market making, trading, investing, cash management, mergers and acquisitions, and other service functions. agreements, which involve securities purchased under agreements to resell, comprised 29.1% of assets. Long positions in securities and commodities accounted for 22.6% of total assets. These figures highlight the industry's significant exposure to market risk and interest rate risk. Additionally, the presence of foreign-issued securities introduces foreign exchange risk and sovereign risk. Liabilities and Leverage Securities firms exhibit high financial leverage, with substantial debt used to finance their asset portfolios. Their liabilities tend to be short-term and market-based. Repurchase agreements, where securities are temporarily lent in exchange for cash, were the primary source of funds, constituting 34.3% of total liabilities and equity. Other major liabilities included payables to customers (21.5%), payables to other broker-dealers (11.9%), and securities sold short for future delivery (8.3%). Nearly 37% of liability financing stemmed from payables incurred in transactions. Equity and Vulnerability Equity capital for securities firms amounted to only 6.1% of total assets in 2018, with total capital (including subordinated liabilities) accounting for 9.1% of total assets. This is lower than the 11.3% capital levels typically held by commercial banks. The lower equity levels reflect the liquidity of securities firm assets, but also leave these firms vulnerable to financial instability. For example, Bear Stearns struggled to finance operations following significant losses in 2007, leading to its acquisition by JPMorgan Chase in 2008. Regulation The primary regulator of the securities industry is the Securities and Exchange Commission (SEC), established in 1934. The SEC's responsibilities include administering securities laws, reviewing new securities offerings, evaluating annual and semiannual reports from publicly held corporations, and prohibiting market manipulation. The National Securities Markets Improvement Act (NSMIA) of 1996 reaffirmed the SEC's primary regulatory role by limiting states' ability to impose additional regulations on federally registered securities firms. State Regulation and Scandals Despite the SEC's dominance, state attorneys general have increasingly intervened in securities- related cases, leading to high-profile investigations and penalties. For example, Merrill Lynch paid a $100 million penalty in 2003 for allegedly giving overly optimistic stock reports to win investment banking business. The 2003 settlement forced major securities firms to pay $1.4 billion in penalties and implement structural changes to prevent conflicts of interest between research and banking operations. Financial Industry Regulatory Authority (FINRA) FINRA, an independent, not-for-profit organization, oversees day-to-day trading practices in the securities industry. It enforces rules, examines firms for compliance, fosters market transparency, and supports investor education. FINRA monitors trading abuses, capital positions, and provides market regulation under contract for major U.S. stock exchanges. In response to concerns about dark pool trading and high-speed trading, FINRA has expanded its oversight to ensure fair trading practices. Congressional Oversight The U.S. Senate Permanent Subcommittee on Investigations examines potential changes in U.S. law to protect the public. Following the financial crisis, the subcommittee investigated the role of investment banks in the crisis, revealing practices like bundling toxic mortgages into complex financial instruments and betting against these securities. Impact of the Financial Crisis The 2008 financial crisis led to significant changes in the securities industry. The Wall Street Reform and Consumer Protection Act of 2010 introduced new regulations, including the establishment of the Financial Services Oversight Council to monitor systemic risks. The act also increased oversight of investment advisors, required issuers to retain financial interests in securitized loans, and mandated that OTC derivatives trading be moved to listed futures markets. Securities Investor Protection Corporation (SIPC) The SIPC, created under the Securities Investor Protection Act of 1970, protects investors against losses from securities firm failures, up to $500,000. Funded by member firms' premium contributions, the SIPC oversees the liquidation of bankrupt broker-dealers and restores customer cash and securities. Unlike the FDIC, the SIPC does not protect against investment losses due to poor investment choices but focuses on recovering assets left with financially troubled firms. Global Issues Securities firms and investment banks are more global in their operations compared to other sectors of the financial institutions industry. Both U.S. and European investment banks vie for business on a worldwide scale, as evidenced by their prominent roles in global debt underwriting and mergers and acquisitions (M&A). Global Underwriting and M&A As seen in Table 16-3, four of the top five underwriters of global debt in 2019 were U.S. investment banks (JPMorgan, Citigroup, Bank of America, and Wells Fargo), with Barclays being the only European bank in the top five. In M&A deals involving U.S. targets, seven of the top ten advisors were U.S. investment banks (including Goldman Sachs and JPMorgan Chase), while three were European banks (including Credit Suisse and Deutsche Bank). Growth in International Transactions Foreign securities trading and underwriting have grown significantly alongside domestic activities. Figures 16-4 and 16-5 illustrate the substantial increase in foreign transactions in U.S. securities and U.S. transactions in foreign securities from 2003 to 2018. Foreign investors' transactions involving U.S. stocks rose from $6,173.7 billion in 2003 to $24,031.1 billion in 2008, before falling during the financial crisis and then recovering to $36,293.0 billion by 2018. Similarly, U.S. investors' transactions in foreign stocks grew from $2,697.7 billion in 2003 to $10,866.3 billion in 2008, dipped during the crisis, and then increased to $11,906.5 billion in 2018. International Security Offerings Table 16-8 shows the total dollar value of international security offerings from 1995 to 2018. The value increased from $443.3 billion in 1995 to $3,781.7 billion in 2007, dropped during the financial crisis, and then fluctuated, reaching $3,067.1 billion in 2018. U.S. issuers offered $564.2 billion in international markets in 2018, up from $72.9 billion in 1995. Strategic Alliances and Market Exits The financial crisis prompted large investment banks to focus on capital, liquidity, and leverage, leading to strategic alliances and exits from certain foreign markets: • Morgan Stanley and Mitsubishi UFJ: In 2008, Morgan Stanley sold a 21% stake to Mitsubishi UFJ and formed a joint venture combining their Japan-based securities businesses. • Citigroup: Faced with government ownership and a challenging environment, Citigroup sold its Japanese securities and asset management units to Sumitomo Mitsui Financial Group and Nomura Trust & Banking. Such moves illustrate the strategies employed by investment banks to maintain competitive global positions. LIBOR Manipulation Scandal A significant global issue was the manipulation of the LIBOR (London Interbank Offered Rate), an average interest rate estimated by leading banks in the London market. This rate affects global financial instruments. The scandal, which became widely known in June 2012, involved several major banks, including Barclays, UBS, and the Royal Bank of Scotland: • Barclays: Paid $450 million in fines in June 2012 for manipulating LIBOR. • UBS: Paid $1.5 billion in December 2012 to settle similar charges. • Royal Bank of Scotland: Settled charges for $610 million in early 2013. The manipulation of LIBOR had far-reaching impacts on the financial markets and led to significant regulatory scrutiny and penalties for the involved banks. ISDAfix Manipulation In addition to LIBOR, investment banks were found to manipulate ISDAfix, a benchmark for interest rate swaps. U.S. investigators uncovered that banks such as Barclays, UBS, Bank of America, JPMorgan Chase, and the Royal Bank of Scotland were involved in distorting ISDAfix to gain trading profits at the expense of companies and pension funds. This manipulation adds to the evidence of systemic efforts by influential investment banks to distort key financial gauges globally. CAPITOLO 7 PENSION FUNDS Summarized Paragraphs Pension Funds Defined: Chapter Overview Pension funds, like life insurance and mutual funds, attract small savers' funds for investment in financial markets, but they offer tax-deferred savings plans for retirement. Established first in 1759 for church ministers' families, the industry grew significantly, with over 680,000 funds by 2016. In 2019, $28 trillion were invested in pension funds, split between private and public sectors. The 2008 financial crisis severely impacted these funds, causing many to delay or adjust retirement plans. This chapter examines the industry's size, structure, trends, and regulations. Size, Structure, and Composition of the Industry The chapter describes pension funds' characteristics, including insured versus noninsured and defined benefit versus defined contribution funds, and provides an overview of private and public pension funds. Defined Benefit versus Defined Contribution Pension Funds Pension plans can be defined benefit or defined contribution. Defined benefit plans guarantee a specific retirement payment based on employment duration and salary, using flat benefit, career average, or final pay formulas. Final CAPITOLO 8 FINTECH INTRODUCTION Fintech adoption has surged, with global VC-backed fintech funding rising from $3.9 billion in 2013 to $35.0 billion in 2019. Major U.S. banks have heavily invested in fintech startups. The global fintech adoption rate increased from 10% in 2015 to 64% in 2019, with China and India leading at 87%. The most used fintech service is money transfer and payments, particularly in China. Fintech also targets SMEs, with high adoption rates in China (61%) and the U.S. (23%). Fintech is defined by the Financial Stability Board as technology-enabled financial service innovations. This chapter explores fintech's disruptive evolution, its relationship with banks, types of innovations, and regulatory approaches. THE EVOLUTION OF FINTECH Fintech has a long history, starting with the pantelegraph in 1865 and the trans-Atlantic telegraph cable in 1866. Major milestones include the Fedwire in 1918, the telex network in 1933, and the Quotron in 1960. ATMs emerged in the late 1960s, followed by BACS, CHIPS, and SWIFT. The 1971 launch of NASDAQ marked a significant fintech transformation. The 1980s and 1990s saw electronic trading and online brokerage rise. Despite these advancements, the number of U.S. bank branches grew until 2012, then declined due to the financial crisis, regulatory changes, and cost- cutting. Supply factors like the 2008 financial crisis damaged banks' reputations, prompting fintech innovation. Banks' risk aversion and regulatory compliance created opportunities for new players. Macroeconomic conditions, especially low-interest rates, pushed FIs to cut costs, spurring fintech growth. Demand factors include the rise of mobile technology and the smartphone revolution led by the iPhone in 2007. Apps have transformed phones into multi-functional devices, driving fintech adoption. Global smartphone penetration reached 66.9% in 2019, with high rates in the U.S., China, and emerging markets. Millennials, who became the largest labor force segment in 2016, drive fintech demand. They are tech-savvy, distrustful of banks due to the financial crisis, and comfortable with digital transactions. Millennials favor mobile payments, online financial advice, and digital currencies. These supply and demand factors collectively fueled fintech's rise. Retail financial services are increasingly digitized, with innovations like mobile wallets, payment apps, robo-advisors, crowdfunding, and online lending. Key developments include Bitcoin's release in 2009, Google Wallet's introduction in 2011, and Ant Financial's "Smile to Pay" in 2017. CHANGING RELATIONSHIP BETWEEN BANKS AND FINTECHS As fintechs gained traction, some predicted the demise of traditional banks due to fintechs' advantages like agility and innovation. Fintechs lack regulatory burdens, legacy systems, and the need to protect existing businesses, leading some to believe banks might transform into "narrow banking" entities. In 2015, JPMorgan Chase’s CEO warned of the fintech threat. Surveys revealed that many CEOs feared fintech disruptions, with significant concerns about market share loss, margin pressure, and increased customer churn. However, banks hold key advantages: large customer bases, compliance expertise, and low capital costs. Instead of competing head-on, banks are now partnering with fintechs. Banks like Goldman Sachs, Citigroup, and JPMorgan Chase have heavily invested in fintech startups. By 2018, 80% of financial institutions had formed fintech partnerships, leveraging each other's strengths for mutual benefit. Banks have shifted focus over time, with recent investments in areas like real estate, capital markets, and wealth management. The rise of banking-as-a-service (BaaS) platforms exemplifies this collaboration, where banks open their APIs to third parties for developing new services. BaaS offers banks new revenue streams and is seen as integral to sustaining growth and innovation. The open banking movement, which began in the UK, is spreading globally, with banks like BBVA and HSBC launching BaaS platforms to meet growing consumer demand for more control over their financial data. This partnership approach is helping banks stay relevant in the digital age. THE TYPES OF FINTECH INNOVATIONS The Basel Committee on Banking Supervision (BCBS) categorizes fintech innovations into three core product sectors and market support services. These sectors include payments, clearing, and settlement services; credit, deposit, and capital-raising services; and investment management services. Payments, Clearing, and Settlement Services Fintech has revolutionized payments through technologies used in clearing, settlement, and point of sale (POS). This sector includes card networks, digital payment platforms, and money transfer companies. Mobile Wallets Mobile wallets store payment information from credit or debit cards. Popular mobile wallets include Apple Pay, Samsung Pay, and Google Pay. They use near-field communication (NFC) technology for contactless payments. As of 2019, Apple Pay had 441 million users, making up 77% of mobile wallet transactions. Peer-to-Peer (P2P) Payments P2P payment services, like PayPal, Venmo, and Zelle, allow users to transfer money using their mobile devices. PayPal, with 267 million active accounts, charges fees for transfers from debit or credit cards. Venmo, popular among millennials, was acquired by PayPal in 2014. Zelle offers same-day transfers between participating banks. Digital Currencies Cryptocurrencies, such as Bitcoin, Litecoin, and Ether, use cryptography to enable secure and anonymous transactions. These currencies are based on distributed ledger technology (DLT). Bitcoin's protocol, released in 2008, is open-source, allowing for the creation of altcoins. Cryptocurrencies are volatile, as seen during the 2018 crash. Central Bank Digital Currencies (CBDCs) Interest in CBDCs, digital forms of central bank money, is rising. They could potentially enhance the payment system and financial inclusion while posing operational risks. Several central banks, including those in Canada, China, Sweden, and Uruguay, are exploring CBDCs. Value Transfer Networks Fintech innovations in wholesale payments are increasing. Examples include blockchain-based programs for international settlements and direct-to-bank deposit services for freelance workers. Business-to-Business (B2B) Payments Companies like Visa and Square are enhancing B2B payment solutions through partnerships and acquisitions. Visa acquired Fraedom to strengthen its B2B payment platform, while Square partnered with Handshake to facilitate B2B e-commerce transactions. Foreign Exchange (FX) Wholesale Fintech firms like Qonto and Kantox are improving FX management and international payments. Kantox's Dynamic Hedging platform helps B2B clients manage market volatility. Digital Exchange Platforms Cryptocurrency exchanges bridge traditional finance and digital currencies, incorporating fiat currencies for easier trading. Top exchanges for USD deposits include Coinbase and Kraken, while crypto-to-crypto exchanges like Binance handle niche altcoins. Security remains a major concern, with high-profile hacks like Coincheck's $500 million theft in 2018 highlighting vulnerabilities. Market Support Services Distributed Ledger Technology (Blockchain, Smart Contracts) Distributed Ledger Technology (DLT) offers a decentralized way to maintain records, unlike traditional centralized systems. Each participant in the network has an independent, identical copy of the ledger. Blockchain, a type of DLT, organizes data into blocks that are chained together. This technology, initially designed for Bitcoin, is now explored for various financial services, including payment, clearing, and settlement activities, as it can simplify processes and improve efficiency. DLT can also enhance market transparency and resilience but poses risks such as security issues, interoperability challenges, and legal ambiguities. Leading banks and consortia like R3 and Hyperledger are developing blockchain proofs of concept, although some members have left these groups to pursue other initiatives. Stock exchanges globally are testing DLT to enhance trading platforms. Artificial Intelligence and Machine Learning AI and machine learning involve advanced techniques for analyzing large data sets, recognizing patterns, and automating tasks. These technologies are increasingly used in financial services to assess credit quality, automate customer interactions, optimize capital allocations, detect fraud, and more. AI and machine learning can significantly reduce costs and improve efficiency in banking operations. Examples include robo-advisory services and AI-driven fraud detection systems. Notable implementations include JPMorgan Chase's Contract Intelligence platform and HSBC's use of AI to detect financial crimes. AI is also being integrated into regulatory compliance (regtech) and insurance (insurtech) sectors. Internet-of-Things (IoT) IoT encompasses connected devices that communicate with each other. In banking, wearable devices like Apple Watch and Barclays' bPay are popular for providing financial services. IoT is also used in global trade transactions, where blockchain and smart contracts ensure transparency and efficiency. Banks are exploring IoT to enhance customer experiences, such as using facial detection technology in branches or Bluetooth beacons to assist disabled customers. Credit, Deposit, and Capital-Raising Services Fintech innovations in this area include crowdfunding, lending marketplaces, mobile banks, and credit scoring. Crowdfunding platforms like KickStarter, CrowdCube, Indiegogo, and GoFundMe allow individuals and nonprofits to raise money online. Lending marketplaces, also known as peer- to-peer (P2P) lending, provide loans to consumers and small businesses using automated algorithms to assess creditworthiness. Notable fintechs in this space include LendingClub, OnDeck, Avant, GreenSky, Kabbage, and SoFi. These platforms offer an alternative to traditional bank loans, often with faster processing and lower costs. Investment Management Services Fintech innovations in investment management include high-frequency trading (HFT), copy trading, e-trading, and robo-advisors. HFT involves executing trades at extremely high speeds, often in microseconds, and was estimated to account for 21% of U.S. equity market volume in 2005, peaking at 61% in 2009. Revenues from HFT have declined since the financial crisis, dropping to below $1 billion in 2018. Firms are now investing in big data analytics, AI, and machine learning to regain a competitive edge. Copy trading allows individuals to mirror the trading actions of successful traders on platforms like eToro, which has grown significantly since its launch in 2006. By 2017, eToro had 8 million registered users. Robo-advisors use algorithms to provide investment advice and management, initially offered by startups like Wealthfront and Betterment, and now adopted by major financial