Banking and Finance (2)

Fair Lending/Community Banks.
Clinton proposed steps to make banks lend more money and provide more services in depressed inner-city neighborhoods. On July 15 the president submitted to Congress his Community Development Banking proposal to stimulate credit flow to inner cities. The measure included an expenditure of some $382 million through fiscal 1997 to establish and expand nontraditional lenders in disadvantaged neighborhoods.
Comptroller Ludwig pressured banks through tougher enforcement of the 1977 Community Reinvestment Act, a measure designed to make more loans available to minorities living in depressed areas. The law was intended to prevent banks from accepting deposits in such areas without making loans available there. Some bankers and federal bank examiners complained that Ludwig was pressuring them to make risky loans. But evidence continued to mount that a black borrower with the same financial profile as a white borrower was more likely to be turned down for credit by a bank. A group founded by consumer activist Ralph Nader accused 49 mortgage lenders of discrimination. A study by Timothy Bates of the New School for Social Research found that black-owned construction companies were denied loans more frequently than similar white-owned firms.

Bank regulators and the Department of Housing and Urban Development instituted testing programs to uncover lending bias and said they would refer any evidence of discrimination to the Department of Justice for prosecution. In December the Clinton administration proposed tough new rules to insure compliance with the Community Reinvestment Act. Objective measurements would be used to evaluate whether a bank's lending patterns in specific neighborhoods were biased when compared with its own overall lending patterns and competitors' lending patterns, whether a bank was investing in a community's growth, and whether it was offering a full array of services. Banks that were found to be flouting the law could face fines or other sanctions.
In November, for the first time, the Federal Reserve blocked a large bank merger because of concerns over possible bias in mortgage lending, preventing Shawmut National Corporation from acquiring New Dartmouth Bank. In December the Justice Department settled its year-old lending discrimination case against Shawmut; the bank's chief executive said Shawmut would renew its application to buy the New Dartmouth Bank.
Nonbank Competition.
Despite high profits in 1993 the long-term outlook for banks looked dim because of a loss of market share to unregulated competitors like finance companies, brokerage houses, and mutual funds.
Bankers were particularly alarmed at the growth of nonbank issuers of credit cards. As of March 31, 13 of the top 50 credit card issuers were owned by nonbank companies. Citicorp continued to reign as the largest credit card issuer, with $36.8 billion in revolving credit outstanding, but the Chase Manhattan Corporation yielded second place to Discover Card Services Inc., issuer of the Discover Card, with $15.2 billion in revolving credit outstanding. Previously, Discover was the only nonbank card among the top ten. But by the end of the first quarter of 1993, Discover was joined by three other nonbanks. One of these was Household International, Prospect Heights, IL, which issued the cobranded General Motors MasterCard (every time a purchase is made with the cobranded card, a percentage of the purchase price is rebated in the form of a credit toward the purchase of a new GM car); Household International had $6.9 billion in revolving credit outstanding. The other two nonbanks were American Express Travel Related Services, Inc., with $6.7 billion, and American Telephone & Telegraph Company, with $6.6 billion. Reacting to the growth in competition, banks began looking for cosponsors of their own. Citicorp cobranded a Visa credit card with the Ford Motor Company.
As far as was legally possible, banks pursued customers who were turning to mutual funds. The Glass-Steagall Act, passed during the Great Depression, prohibits banks from underwriting funds; however, banks can sell funds underwritten by others and can serve as fund advisers, thereby reaping fees. Since the late 1980s over 100 banks have started their own mutual fund families, with the banks serving as advisers. By mid-1992 banks accounted for over 14 percent of all stock and bond mutual fund sales. In the 12 months ended June 30, 1993, banks increased the mutual fund assets they managed by 36 percent, to $190.9 billion. That outpaced the 23 percent growth recorded by the mutual fund industry overall, to $1.8 trillion in assets.
In 1993, Wells Fargo & Company permitted ATM cardholders who also owned its mutual funds to purchase additional shares, transfer money between funds, or sell shares and transfer the proceeds into a bank account. In another sign of the mutual fund push, Bankers Trust Company linked up in August 1993 with discount broker Charles Schwab Corporation to sell mutual funds to the corporate retirement-plan market. Then, in December, Pittsburgh-based Mellon Bank Corporation acquired the Dreyfus Corporation, the sixth-largest U.S. mutual fund company. Once the deal was completed, Mellon would derive 60 percent of its annual revenue from mutual fund fees rather than from interest on loans.
The increased mutual fund activity by banks worried some members of Congress; they were concerned that bank customers might not realize that funds marketed by banks were not guaranteed by federal deposit insurance funds. In October, House Banking Committee Chairman Henry B. Gonzalez (D, Texas) and Representative Charles E. Schumer (D, New York), a member of the banking panel, introduced a bill to regulate fund sales by banks. The banking industry opposed the plan, claiming it would add to government red tape already diluting industry profits.
President Clinton proposed to save $4.3 billion by having federally guaranteed student loans be made directly through the Education Department. The president said the system whereby the government paid private lenders such as banks to provide the loans was needlessly expensive for students. Protests by the banking industry did not fall on deaf ears, and the legislation that was eventually passed allowed for a test of the program: The Education Department would be permitted to make up to 50 percent of guaranteed student loans for a period of five years. In 1998, Congress would have the option of expanding the program.
Bank Mergers.
Banks' loss of market share to unregulated competitors caused a flurry of bank mergers in 1993. The third quarter of the year was the biggest deal-making period since the third quarter of 1991, when mergers were announced between BankAmerica Corporation and Security Pacific Corporation and between Chemical Banking Corporation and Manufacturers Hanover Corporation. Deals in the third quarter of 1993 totaled $6.6 billion, compared to $3.3 billion in the second quarter. The fourth quarter of 1993 featured the largest single deal since 1991, with the $3.8 billion merger of Society Corporation of Cleveland, OH, with Keycorp of Albany, NY.
BankAmerica, which cut 20,000 jobs following its 1991 merger, announced plans in late October 1993 to eliminate 3,750 more jobs, or 3.8 percent of its work force, by the end of 1994, because of the weak California economy. The new cuts were expected to save about $250 million in annual expenses.
S&L Bailout.
The government cleanup of failed savings and loan associations seemed imperiled for most of the year because of congressional reluctance to provide the Resolution Trust Corporation, the agency in charge of the bailout operation, with additional funds. Critics claimed the RTC was inefficient and inept. A report by the agency's own inspector general revealed that the accounting firm Price Waterhouse and Company, working as a subcontractor for the RTC in a San Diego thrift, had billed the agency 67 cents per copy for copying over 11 million documents at that one institution, resulting in a cost overrun of millions of dollars. As a result of such criticism, Albert V. Casey, chief executive officer and president of the RTC, resigned on April 1 after 17 months on the job. (Late in the year, after four months of waiting for the Senate Banking Committee to schedule confirmation hearings, his proposed successor, Republican real estate developer Stanley Tate, withdrew his nomination. His lack of success was attributed to a number of causes, including the disinclination of some Democratic senators to confirm a contributor to Republican campaigns.)
The Clinton administration initially sought $42 billion to complete the cleanup of failing S&Ls but agreed to accept less in the face of opposition from both the Senate and House. Late in the year a congressional committee brokered a compromise between versions of the legislation. The compromise measure finally adopted called for $18.3 billion to finish the S&L cleanup.
International Banks.
European banks, meanwhile, were still suffering from the same asset quality problems that had hobbled their American counterparts a few years earlier and from a lingering recession. Crédit Lyonnais, a French state-owned bank, turned in one of its worst performances in 20 years. Analysts said credit problems at Bank Nederland, its Dutch subsidiary, contributed to Crédit Lyonnais's problems.
A British bank, Barclays, reported the first loss in its 97-year history in March, when it was compelled to reserve 2.6 billion pounds sterling against doubtful credits and, as a result, was forced to cut its dividend.
Banks in Sweden were rocked by bad news. At the end of June the Swedish government paid $50 million to cover an interest payment missed by Swedbanka, one of Scandinavia's biggest banks. Earlier, the government had to take over and bail out Gotabanken and Nordbanken. Also in June, Italy's Ferruzzi group announced its inability to meet obligations to lenders. More than 100 banks, including some of the largest U.S. and European institutions, were unable to recover hundreds of millions of dollars in loans.
Internationally, there was much fretting by regulators about the risks of the $6 trillion derivatives market. In this market banks trade interest income produced, or derived, from securities in their portfolios, such as stocks, bonds, currencies, or commodities, to help protect themselves from interest rate fluctuations. Anxious to avoid more regulation, the Group of Thirty, a Washington, DC, think tank representing some of the biggest international banks, called for its members to voluntarily adopt more rigorous accounting standards and to make additional disclosures about their derivative activities. When the banks appeared to be ignoring the recommendations, they received a stern warning from the U.S. Federal Reserve Board that governments would act if they did not.
The movement toward economic union in Europe prompted France in July to privatize two state-owned banks, Banque Nationale de Paris, one of its largest financial institutions, and Société Nationale Elf Aquitaine, a small, retail bank. Only members of the European Community were permitted to have more than a 20 percent stake in the privatized banks, prompting protests from the United States that France was engaging in protectionism.
Cross-border acquisitions also picked up in Europe. France's Crédit Lyonnais, the world's eighth-largest bank, acquired Bank für Gemeinwirtschaft, a German bank. Commerzbank, another German institution, acquired Paris-based Caisse Central de Réescompte.
Microsoft ® Encarta ® 2007. © 1993-2006 Microsoft Corporation. All rights reserved.

Banking And Finance (1)

Archives consist of articles that originally appeared in Collier's Year Book (for events of 1997 and earlier) or as monthly updates in Encarta Yearbook (for events of 1998 and later). Because they were published shortly after events occurred, they reflect the information available at that time. Cross references refer to Archive articles of the same year.
1993: Banking And Finance
Historically low interest rates in 1993 helped the U.S. banking industry achieve record profits and provided an escape hatch for debt-laden consumers. Rates on 30-year mortgage loans fell to under 7 percent, the lowest since the 1960s.
There was a downside to the good news, however. Congress appeared unable to pass legislation needed to modernize the banking industry, possibly setting the stage for a round of industry consolidation and failures later in the decade. And low yields drove savers who usually relied on bank accounts backed by government guarantees into riskier instruments such as mutual funds in order to maintain adequate returns. Returns on six-month certificates of deposit dropped below 3 percent. Five-year CD rates fell below 4.5 percent in October. Meanwhile, the assets of stock mutual funds rose 22 percent during the first half of the year, to $580.4 billion, and bond fund assets were up 16 percent, to $673.1 billion.
Defendants in various banking scandals made news again during the year, including Clark Clifford and Robert Altman, both of whom had been charged in 1992 in connection with the Bank of Credit and Commerce International (BCCI) case.
In Europe the year saw many banks beleaguered by credit problems and the effects of recession.
Prime Rate.
Slow economic growth kept interest rates in the United States at their lowest levels since the 1950s. On October 18, Morgan Guaranty Trust Company cut its prime rate, the rate it charges to its best customers, to 5.5 percent, down half a percentage point. A Morgan spokesman said the bank decided on the hefty cut because there was growth in loan demand, low inflation, and a spread of three percentage points between the Federal Reserve Board funds rate (the rate at which banks can borrow money overnight) and the prime — a very big spread by historical standards. Analysts had been expecting banks to cut the prime rate, which had lingered at 6 percent since July 1992, but only by a quarter of a percent. A brief sell-off of bank stocks followed Morgan's action, as analysts predicted a drop in bank profits because of lower rates on loans. However, most of the rest of the banking community declined to follow Morgan's lead.
Bank Profits.
Overall, the more than 11,000 commercial banks in the United States enjoyed a banner year in 1993. The industry reported $10.4 billion in earnings during the second quarter, just $455 million below the record earnings of the first quarter. The third quarter saw a new record as earnings reached $11.5 billion. For the first nine months of 1993 banks earned $32.6 billion, $8.5 billion more than in the corresponding period in 1992. Citicorp, the largest U.S. banking company, saw its third-quarter earnings triple to $528 million, a remarkable performance for a bank believed to have been on the Federal Deposit Insurance Corporation's list of troubled banks in 1991.
As a result of the strong earnings bank stocks generally outpaced the market, and shareholders saw dividends in the first half of the year mount to $8.7 billion, 50 percent more than in the same period of 1992.
Federal Deposit Insurance Fund.
The surge in profits reduced strains on the Federal Deposit Insurance Corporation's Bank Insurance Fund. In August 1993 the fund reported a balance of $6.8 billion and a reserve ratio of 35 cents for every $100 of insured deposits. At the end of 1992 the fund had reached negative $100 million. In addition, during 1993 the FDIC was able to repay the U.S. Treasury a $2.5 billion line of credit it had requested in 1991, when the outlook for banks was far more dismal.
Many banks that had been in danger of failing recovered because of the low interest rates. By December 15, 1993, 42 banks with $3.8 billion in assets had failed, compared to 120 banks with $44.2 billion in assets the previous year. The number of troubled banks was down by 125 in the third quarter of 1993, for a total of 664. The FDIC estimated total costs to the fund for the year at $500 million, compared to $7 billion in 1991 and $4.7 billion in 1992. Total assets at problem banks dropped by $75 billion in the first nine months of 1993, to $379 billion.
Because of the turnaround the FDIC estimated that it would reach its congressionally mandated reserve ratio of $1.25 for each $100 in deposits as early as 1996. Earlier estimates had the fund reaching the required level in 2002.
Consumer Debt.
The low interest rates also enabled consumers to strengthen their balance sheets. With rates for 30-year mortgages under 7 percent for the first time in nearly 25 years, many people refinanced mortgage loans and used the savings to pay down more expensive debt. They also used home equity loans, with their tax-deductible interest rates, to replace other forms of borrowing. Data published by American Banker in June showed that credit card loans at commercial banks fell in 1992 for the first time since 1981. Total card loans outstanding fell 1.9 percent, to $136.4 billion. Mortgage loans rose 8.2 percent, to $390.1 billion, and home equity loans rose by 4.3 percent, to $73.3 billion.
Credit Crunch.
Lawmakers, especially those from the depressed New England states, were angry that banks were not making more new loans in the face of record profits. They were especially disturbed by reports that small businesses in their states could not secure lines of credit. Banks blamed the situation on weak customer demand because of the soft economy, new sources of corporate financing, and burdensome laws passed by Congress in 1991 in reaction to a spate of bank failures. (These laws require banks to maintain very high levels of capital, thus reducing funds that would otherwise be available for loans.)
Surveys by the National Federation of Independent Business showed that borrowing by its 600,000 members was at a 20-year low because of concerns about the economy. As a result, President Bill Clinton announced a credit crunch initiative on March 10, when he introduced proposed new banking regulations meant to reduce paperwork and give bankers incentives to lend once again. Comptroller of the Currency Eugene A. Ludwig, regulator of national banks, established an appeals process for bankers unhappy with the grading of loans by federal bank examiners. Ludwig, the de facto head of the FDIC during 1993, also limited that agency's ability to examine banks regulated by the Office of the Comptroller of the Currency. This move, although unpopular with the FDIC, was praised by bankers, sometimes subjected to multiple examinations by federal regulators in a given year.

American Express Company (2)

IV
INTERNATIONAL BANKING SERVICES
During World War I (1914-1918) the U.S. government nationalized and consolidated express deliveries on American railroads, eventually forcing American Express to discontinue its express business in 1918. In an effort to maintain steady revenues, American Express diversified by offering international banking services in 1919. After steady but relatively modest overseas growth during the 1920s and 1930s, the company dramatically increased the number of its offices around the world during the late 1940s and 1950s.
V

AMERICAN EXPRESS CARD
In 1958, eight years after Diners Club came out with the first credit card that could be used at a variety of establishments, American Express introduced its own credit card. The American Express credit card offered cardholders the convenience of being able to buy goods and services without needing cash at the time of purchase. The company generated revenues by charging cardholders an annual fee and by receiving a small percentage of card purchases from participating businesses. American Express did not charge cardholders interest for using the card, but it required them to pay their balances in full each month. Within three months of the card’s introduction, half a million people became American Express cardholders. In less than ten years, 2 million people carried American Express credit cards and annual charges on those cards exceeded $1 billion.
VI

DIVERSIFICATION
During the 1960s, 1970s, and early 1980s American Express grew into a global financial giant, acquiring a number of companies, including Fireman’s Fund Insurance Company in 1968 (which it sold in 1985) and the brokerage firms Shearson Loeb Rhoades Inc. in 1981 (which later grew into Shearson Lehman Brothers Holdings Inc.), Investors Diversified Services in 1984, and E. F. Hutton in 1987.
In 1987 the company introduced the American Express Optima credit card to compete with the growing popularity of cards issued by competitors MasterCard and Visa. Unlike its original American Express credit card, the Optima card did not require cardholders to pay their balances in full each month. Instead, like MasterCard and Visa, the Optima card allowed cardholders to pay balances in installments, plus interest.
VII

RECENT DEVELOPMENTS
In the late 1980s and early 1990s a downturn in the U.S. economy, coupled with increased competition from other credit card companies, led to a sharp decrease in earnings for American Express. In 1991 the company initiated a major reorganization at a cost of $110 million. At the same time American Express invested $155 million in a reserve to cover expected losses from its various credit lines.
Harvey Golub took over as chairman of American Express in 1993. Golub sold many of the company’s holdings and cut millions of dollars in costs. Earnings at the company rose steadily during the mid-1990s, as American Express broadened its credit card business, strengthened its investment-services group, and expanded its international business holdings. The number of American Express cardholders grew from 26 million in 1993 to 59 million in 2001.
Microsoft ® Encarta ® 2007. © 1993-2006 Microsoft Corporation. All rights reserved.

American Express Company (1`)

I

INTRODUCTION
American Express Company, financial and travel services company based in New York City. American Express invented the traveler’s check and introduced one of the first credit cards in the United States. These financial services established American Express worldwide and helped build the company into a multibillion-dollar corporation with dozens of subsidiaries.
II

FOUNDING
American Express began in 1850 in New York City as a company that transported valuables. It resulted from the merger of three rival express transport companies: Wells & Company; Butterfield, Wasson and Company; and Livingston, Fargo and Company. Henry Wells served as the first president of American Express and William G. Fargo was the vice president. In addition to their duties at American Express, Wells and Fargo began a separate company two years later, Wells Fargo & Company, which provided express delivery and banking services to California.
American Express prospered in the 1850s by transporting money and other valuables on rail and steamship lines in areas north and west of New York. The company grew even larger during the American Civil War (1861-1865) by transporting supplies, parcels, and other items for the Union Army.
III

MONEY ORDERS AND TRAVELER’S CHECKS
Fargo became president of American Express after Wells retired in 1868. Fargo died in 1881 and was succeeded as president by his brother, James Fargo, who further expanded the business. He guided the introduction of the money order in 1882 and the traveler’s check in 1891. Most money orders could be issued and redeemed only in banks or post offices, which distinguished them as exceptionally reliable draft notes—or certificates negotiable as money—for a variety of personal and business transactions. The American Express traveler’s check was a draft note purchased from a bank or directly from American Express. It could be redeemed for goods or services in many businesses around the world.
The American Express traveler’s check was an immediate success with travelers who found that the checks were easier to redeem than letters of credit from banks, which were commonly used overseas instead of cash. In addition, travelers preferred American Express traveler’s checks because the company would reimburse them if the checks were lost or stolen. Traveler’s checks provided a substantial infusion of revenue to the company, and helped establish the American Express brand name among American travelers.

Getting the Best Exchange Rate When You Travel Abroad

Travel writer and consumer advocate Ed Perkins offers travelers some advice on how to lower their costs while exchanging currency. He recommends using a credit card and an ATM card to avoid the high exchange rates that are usually attached to travelers checks and the fees charged by currency exchanges.
Getting the Best Exchange Rate When You Travel Abroad
By Ed Perkins
Finding the best ways to exchange currency has always been one of the most nettlesome questions for foreign travelers. However, these days the widespread use of plastic money—credit cards and debit ATM cards—makes the question much simpler.
The best strategy for exchanging currency today may be summed up in two basic rules: Put as much of your foreign expenses on a credit card as you can, and use your ATM card whenever you need to get cash. With a little bit of background and research, you can spend more of your money on travel and less on fees.
Getting the Best Exchange Rate When You Travel Abroad
As a visitor to a foreign country you will always lose at least a little in the process of exchanging currency. Your objective is to keep that loss as low as possible. Here are some facts about currency exchange that may surprise you:
* On a retail transaction—exchanging United States currency or travelers checks for foreign currency at a bank or exchange office—you usually lose from 4 to 8 percent on the transaction. You will lose even more if you exchange currency at a hotel.
* You won’t lose less money by exchanging currency in the United States before you leave. In fact, U.S. bank rates are usually worse than bank rates overseas. Buying travelers checks in a foreign currency before you leave home doesn’t help matters: You will simply take the loss here when you buy them instead of taking it overseas when you cash the checks.
* When you use a credit card or a debit ATM card in a foreign country the least you can lose is the (approximately) 1 percent fee that the international MasterCard and Visa networks charge to make the actual exchange. With American Express and Diners Club the fee is about 2 percent.
* When you charge a foreign purchase to a bank credit card, such as MasterCard or Visa, all you lose with some cards is the 1 percent the issuer charges for the actual exchange. Other banks, however, add a surcharge of 2 to 3 percent on transactions in foreign currencies. The decision whether or not to surcharge is up to the bank that issues the card, not MasterCard or Visa. Some of the big banks that don’t surcharge are Capitol One, HFC, and US Bank. Among those that do surcharge are Chase, Citibank, First USA, and Providian. Even with a surcharge, however, you generally lose less with a credit card than with currency or travelers checks. American Express and Diners Club don’t surcharge beyond the 2 percent fee.
* When you use a debit card, such as Cirrus or Plus, to withdraw foreign cash, the conversion fee is 1 percent, the same as with a credit card. In addition, you pay a fee, established by your bank, for each withdrawal. The typical fee for an overseas withdrawal is 2 to 3 dollars, although a few banks charge more; you pay the same fee, no matter how much or how little you withdraw. A few small banks offer “no-fee” ATM cards to attract business.
* When you use a credit card to get foreign cash, the withdrawal is treated as a cash advance, and you are immediately subject to interest charges in addition to the 1 percent conversion loss and a fee of 3 dollars or more.
A basic strategy for exchanging currency
Take maximum advantage of your credit card and debit ATM card by following this basic strategy:
* Use a credit card to lose the least on your foreign purchases. By researching the different cards before you leave on a trip, you can keep your losses to around 1 to 2 percent.
* For the cash you need, keep your losses to a minimum by withdrawing foreign currency with an ATM debit card. If you withdraw in amounts of $200 or more, the percentage loss is small. If you use a credit card to withdraw cash, you’ll lose a lot more. Don’t use a debit card for small withdrawals.
* Don’t use travelers checks as your primary means of foreign payment. But do take along a few $20 checks or bills to exchange at retail for those last minute or unexpected needs.
Microsoft ® Encarta ® 2007. © 1993-2006 Microsoft Corporation. All rights reserved.

Corporate Finance

I

INTRODUCTION
Corporate Finance branch of economics concerned with how businesses raise and spend their money. Companies spend or invest funds in projects that might make the firm more profitable, such as a new factory or an improved product. Corporate finance involves selecting projects that maximize profits and make the best use of a company's funds. Sometimes businesses can fund these projects on their own. Other times businesses must raise funds from outside the company. Corporate finance also involves finding the best way for businesses to pay for their projects.
II

CORPORATE OWNERSHIP
Small businesses may be owned by a single individual, but major corporations are far too large to be owned in this way. Instead corporations are owned by many people, called shareholders, who own shares of stock. Investors purchase stock because it allows them to share in the company's profits, although there are no guarantees that the company will be successful. Each share of stock represents ownership of a portion of the firm and its possessions, or assets. For example, Exxon Corporation has about 600,000 shareholders, who together own a total of about 1.2 billion shares of stock.
Shareholders who possess a large number of shares own a larger portion of the company than those who possess only a few shares. For example, an individual who owns one share of Exxon stock owns just under one-billionth of the company. At the other extreme, a large financial institution, such as an insurance company or a company that manages investments, may own several million shares of Exxon stock. About half the shares of large corporations are owned directly by individuals. The other half are owned by financial institutions.
Shares of stock are bought and sold on a number of stock exchanges. For example, Exxon's shares are regularly bought and sold on the New York Stock Exchange. At the end of 1995 Exxon's shares were priced at $80 each. At that price it would have cost about $100 billion to buy all of Exxon's stock.
Although a corporation's shareholders own the company, they do not manage it. Instead they elect a board of directors who hire key company executives and review their job performance.
III

INVESTMENT DECISIONS
Corporate investment decisions often involve substantial amounts of money. Many investment decisions are also difficult to reverse and can affect the company's business far into the future. For example, in 1966 Boeing Company, an airplane manufacturer, decided to invest about $1 billion to develop the 747 jumbo jet. This investment delivered long-term benefits as the company was still selling the jets 30 years later. It was also able to take advantage of its experience with the 747 to develop new kinds of aircraft.
A business regards an investment as successful if it increases the wealth of the shareholders who own the company. This is accomplished when the firm earns profits and passes them back to the shareholders either in the form of dividends or as increases in the value or price of the stock. Dividends are a share of profits paid to shareholders as cash or as additional shares of stock. Profits or earnings that are not distributed to shareholders stay with the firm and are called retained earnings. These earnings influence the value of the stock because they increase the total asset value, or total amount of assets, of the firm. Because the value of their company's possessions has increased, the shareholders own stock that is worth more. If the firm realizes retained earnings of $1 per common share, it will add $1 to the value of each share. However, since many forces influence stock prices, the actual price of the stock will probably fluctuate and be more or less than the additional $1 per share.
Investment decisions—that is, deciding what projects to invest in—are based on two criteria: the expected rate of return and the risk or uncertainty of achieving the expected rate of return. The project's rate of return, or simply its return, is a measurement of its profit. A financial manager estimates the return based on forecasts of potential sales, expenses, and profits that might occur from an investment. For example, a company might have an opportunity to invest in a project that costs $100 million. If the project is expected to produce a profit of $10 million, this equals a rate of return of 10 percent on the investment of $100 million.
Before evaluating the rate of return, a financial manager must also consider the return's risk. The manager must consider the chances of earning or losing money on the project and how great the profits or losses could be. For example, if the company has a 90 percent chance of earning the $10 million return, the risk is rather small. On the other hand, if the company has only a 5 percent chance of earning the $10 million return, the project is very risky. Expected rates of return are higher with risky projects because they must compensate for the project's uncertainty to attract investors. Although their returns are not guaranteed, higher risk projects have a potential for greater profit.
Whether or not the company should go ahead with the project depends on what the $100 million could earn if invested differently. The company should accept any project that is expected to earn a higher return than shareholders can earn with another investment. For example, the shareholders could invest their $100 million by buying real estate. If the shareholders could earn a 20 percent return on their real estate investment, they are giving up that opportunity to invest in the company. In other words, 20 percent is the cost of investing their capital in the project, or the cost of capital. The firm should only accept projects whose expected return exceeds the shareholder's cost of capital.
In addition to investing in projects, firms also buy and sell entire businesses. Sometimes this takes place with a mutual agreement to merge or combine two companies into one. In other cases one firm, the buying firm, goes against the wishes of another firm's management, the target firm, and attempts a takeover. For example, a company can appeal directly to the target firm's shareholders by offering to buy their stock. If the buying firm acquires enough of the target firm's stock, it can control the target firm's activities.
IV

RAISING MONEY FOR INVESTMENTS
Investments require cash. There are three common ways a corporation may be able to raise this cash: (1) by paying smaller dividends, (2) by borrowing, or (3) by selling more stock. Each method has advantages and disadvantages.
A firm can finance projects by paying smaller dividends. By paying out less of its profits in dividends, the company can keep more of its profits as retained earnings and use them to fund its investments. Using retained earnings to finance projects appeals to managers because they can avoid paying interest. However, the shareholders may not like it if their dividend becomes smaller. Also, sometimes the firm needs more money for a particular project than it has available in retained earnings.
A company can also choose to borrow money to fund its projects. A firm can either borrow from a bank or directly from investors by issuing bonds. Although a firm must pay interest if it borrows money, it can deduct the interest from its profits and therefore pay less in taxes. However, there are limits to how much a firm can borrow, and too much borrowing could lead to bankruptcy.
Selling stock is a third way companies can raise funds. Unlike a loan, the funds received from the sale of stock belong to the company and do not have to be repaid. As a consequence, the firm does not have the expense of paying interest. However, the firm must still earn a certain return on its investment to obtain the cash to pay dividends or devote to retained earnings. Businesses also may not want to issue stock because the costs of issuing stock, such as fees for legal and banking services, are usually higher than for issuing bonds.
A financial manager must consider factors other than cost when deciding how to raise money. For example, if a firm tries to raise new funds, the public will speculate about the company's plans. If investors think the plans are a bad idea the company's stock price could fall.
International financial markets have become increasingly important sources of funds. United States firms frequently raise money in overseas financial centers such as London or Tokyo. Loans from abroad often have a lower interest cost to domestic U.S. corporations because foreign banks are not subject to the restrictions of the U.S. Federal Reserve System. For example, instead of borrowing dollars from a bank in the United States, American firms may borrow dollars that have been deposited in London or Tokyo banks. These are known as Eurodollars. Eurodollars are U.S. dollars held in banks outside of the United States. Similarly, instead of issuing bonds in the United States, U.S. firms may issue bonds in a foreign country to a group of international investors. These are called Eurobonds. Eurobonds are bonds sold outside the country whose currency is used to write the bond. For example, a bond denominated in U.S. dollars issued by a Japanese bank is a Eurobond.
V

MANAGING RISK
Events outside the control of a corporation can affect the firm and its financing decisions. For example, a change in the interest rate can suddenly make borrowing money very inexpensive or very costly. From 1975 to 1995, interest rates in the United States were as high as 15 percent and as low as 3 percent. Many economic factors, such as changes in the price of oil or the price of foreign currency, can affect businesses as well.
Corporate financial managers need to make sure that potential economic fluctuations do not threaten the firm. A variety of tools, known as derivatives, help manage the risk of such events occurring. Four important kinds of derivatives include (1) futures, (2) forwards, (3) options, and (4) swaps. Futures are promises to buy or sell something in the future at a price that is agreed upon today. For example, a candy manufacturer might commit to purchasing a specified quantity of cocoa at a specified price from the producer in six months. Futures are traded on organized futures exchanges, such as the Chicago Mercantile Exchange or the Chicago Board of Trade. Forwards are similar to futures, but they are arranged directly between a firm and a bank. Options give a firm the right to buy or sell something in the future at a price that is agreed upon today. For example, if the candy-manufacturer does not know how much cocoa will be needed in six months, it could take out an option to buy cocoa at a certain price. Swaps involve firms swapping one set of payments for another. For example, an American firm may agree to make a series of dollar payments to a Japanese bank, while the bank in return promises to make a series of yen payments.
Derivatives are very popular. For example, worldwide trading of futures amounts to about $35 trillion a year. Most firms use derivatives to reduce risk, but some use them to speculate by buying and selling derivatives in hopes of earning a profit. When these speculations don't work out, losses can be substantial. For example, the United Kingdom's Barings', one of the world's oldest banks, collapsed in 1995 when futures speculation by one of its traders in Singapore resulted in losses of over $1 billion.
Methods of corporate finance continually evolve as financial managers invent new ways to raise money and avoid risk. Smart investment and financing decisions are crucial to a firm's success.
Microsoft ® Encarta ® 2007. © 1993-2006 Microsoft Corporation. All rights reserved.

Citigroup Inc.

I

INTRODUCTION
Citigroup Inc., world’s leading financial services firm. Formerly known as Citicorp, the company merged with Travelers Group, an insurance, brokerage, and banking company, in 1998 to form a single company called Citigroup. It is the holding company for Citibank, one of the biggest banks in the United States and the world’s largest issuer of bank credit cards. Citibank is a global, full-service banking company that provides corporate and personal financial services in more than 100 countries and territories.
Citigroup’s other subsidiaries include brokerage firm Smith Barney and Primerica Financial Services, which offers life insurance, mutual funds, and consumer loans. Citigroup is based in New York City.
II

EARLY HISTORY
Citibank traces its roots to the first bank to be chartered (authorized) by the federal government, the Bank of the United States, founded in Philadelphia, Pennsylvania, in 1791. When the federal government did not renew the bank's charter in 1811, Colonel Samuel Osgood took control of the New York branch and reorganized it as the City Bank of New York. The bank operated primarily as a source of credit for merchants.
To create a market for government bonds to raise money for the American Civil War (1861-1865), the U.S. Congress established the first national banking system in 1863. City Bank acquired a national charter and became the National City Bank of New York (NCB). Under the leadership of James Stillman in the late 1890s, NCB became a prime lender to big corporations.
By 1909 NCB was the nation’s largest bank, with over $300 million in assets. In 1914, after the Federal Reserve Act allowed federally chartered banks to open branches overseas, NCB opened an office in Buenos Aires, Argentina, becoming the first national U.S. bank with a foreign department. In 1928 the bank became the first commercial bank to offer personal loans. At the time, commercial banks did most of their business with corporations and government agencies, and savings banks handled the consumer market.
In 1955 NCB merged with the First National Bank of New York and became the First National City Bank of New York. The new bank became known as Citibank, based on the designation NCB had chosen as its telegraph address in 1866. The name became official in 1974. Citibank pioneered the use by banks of holding companies (corporations that exist only to hold the shares of another company) in order to expand nonbanking activities, creating First National City Corporation in 1967. It was renamed Citicorp in 1974.
III

INNOVATION AND EXPANSION
In 1961, to compete with government bonds, Citibank invented the certificate of deposit (CD), a form of savings account that pays a higher rate of interest in exchange for a longer time commitment by the investor. In the 1970s Citibank became a leader in issuing Visa and MasterCard credit cards. By 1980 it had issued cards to 6 million people in the United States. That same year, the company moved its credit card operations to South Dakota, where state law allows banks to charge a higher rate of interest than New York state law.
In 1981 Citibank surpassed Bank of America (present-day Bank of America Corporation) as the largest U.S. bank. However, during the late 1980s Citibank reported billions of dollars in losses due to loans to developing countries and the economic downturn of the commercial real estate market in the United States. The revenues from Citibank’s many foreign franchises helped the company quickly regain profitability, and it remained the largest U.S. bank into the 1990s.
The 1996 merger of Chase Manhattan Corporation and Chemical Bank Corporation, both of New York, unseated Citibank as the largest bank in the United States. That same year, the United States Department of Justice (DOJ) began investigating Citibank’s involvement with the brother of former Mexican president Carlos Salinas de Gotari. In 1995 the Mexican government charged Raul Salinas with “illicit enrichment” after tracing numerous overseas accounts to him. The DOJ sought to determine whether Citibank violated U.S. money-laundering laws by helping Salinas move nearly $80 million from accounts in Mexico to Switzerland. The United States Government Accounting Office reported in 1998 that Citibank violated its internal regulations when it failed to run a background check on Salinas and did not verify the source of Salinas’s money.
IV

RECENT DEVELOPMENTS
In 1998 Citicorp announced plans to merge with Travelers Group to create a $700 billion company (based on assets) called Citigroup. Travelers Group, founded in 1864, was the first company in the United States to sell accident insurance. It later offered life insurance, annuities, liability, and, in 1897, the first auto insurance policies. In the late 1970s and early 1980s the company started to acquire financial services firms. In 1993 entrepreneur Sanford Weill bought Travelers Group and made it the holding company for his other firms, which included Commercial Credit, Primerica Financial Services, and Smith Barney. He retained the Travelers Group name and its red-umbrella logo. In 1997 Travelers Group’s Smith Barney merged with investment firm Salomon Brothers to create Salomon Smith Barney. The division later reverted to the name Smith Barney.
Federal regulators approved the consolidation of Citicorp and Travelers Group, valued at approximately $70 billion when announced, in 1998. The merger gave each company’s shareholders 50 percent of the combined enterprise. The merger was largely a failure, however, and in 2002 the company decided to spin off one of the principal components of the deal, Travelers Property Casualty Corp.
In 2003 Citigroup faced an investigation by the New York State attorney general into allegations that its stock analysts issued fraudulent reports on companies in an effort to gain their investment banking business. In a settlement the company agreed to pay a $400 million fine and to separate its stock research from its investment banking business. In addition, one of its former stock analysts was banned from the securities business for life.
In 2005 Citigroup announced that it would spin off another component of the Travelers Group by selling Travelers Life & Annuity to the insurance giant MetLife Inc. for about $11.5 billion. The sale would make MetLife the largest individual life insurer in North America. As part of the deal, MetLife agreed to make some of its products available through Citigroup distribution channels, such as Smith Barney and Citibank branches.

Microsoft ® Encarta ® 2007. © 1993-2006 Microsoft Corporation. All rights reserved.