Explain how the liquidity position of finance companies differs from that of depository institutions such as commercial banks.
A commercial bank is a depository institution which accepts deposits from the public and grants loan for various purposes. The commercial banks earn profit in the form of interest and service charge by lending loans from the deposits collected.
Answer and Explanation:
The financial companies raise their funds by borrowing, by issuing bonds, commercial paper and other instruments which are redeemable or the deposits can be withdrawn after a specific period. The maturity is said to be certain so these companies can anticipate the need of additional funds. They can raise additional funds by issuing additional securities.
On the other hand, the depository institutions, such as commercial banks, accept deposits from the general public which is the primary source of funds. The withdrawal and deposits can be done at any time which causes serious liquidity problems for the commercial banks.
Hence, it can be said that finance companies face lessor liquidity risk than the depository institutions.
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from Corporate Finance: Help & ReviewChapter 8 / Lesson 7