Question

Metropolitan Nashville and Davidson County issues $25 million of municipal revenue bonds to finance a new domed stadium for the Tennessee Titans football team. The bonds have a face value of $10,000 each, are somewhat risky, and have a maturity of 20 years. Enterprise Bank of Nashville purchases one of the bonds using the $5,000 received from Sarah Levien and Ted Hawkins, who each purchased a 6?month certificate of deposit from the bank. Explain the intermediation services provided by Enterprise Bank in this transaction. Illustrate with T?accounts.

Answer 1

If Sarah or Ted had $10,000 and had wanted to assume the market risk the bonds, they may have purchased the bond in the direct financial market from a broker or dealer.  Each likely prefers the government guarantee of the CD, are able to make the investment with a smaller denomination of $5,000, and have the liquidity with a known "penalty for early withdrawal."  The Enterprise Bank now has a possibly tax-free source of income on the municipal bond, is confident of its expert evaluation of the credit risk, is well diversified with other, out of town and state securities, and can purchase the bonds with very low transaction costs.  Many banks are underwriters of municipal securities, carrying an investment inventory as a dealer.  The City of Nashvillehas a stadium asset(?), a bond issue IOU, while Sarah and Ted have CD assets on