What Is Asset/Liability Management?

Asset/liability management is the process of managing the use of assets and cash flows to reduce the firm’s risk of loss from not paying a liability on time. Well-managed assets and liabilities increase business profits. The asset/liability management process is typically applied to bank loan portfolios and pension plans. It also involves the economic value of equity.

Understanding Asset/Liability Management

The concept of asset/liability management focuses on the timing of cash flows because company managers must plan for the payment of liabilities. The process must ensure that assets are available to pay debts as they come due and that assets or earnings can be converted into cash. The asset/liability management process applies to different categories of assets on the balance sheet.

[Important: A company can face a mismatch between assets and liabilities because of illiquidity or changes in interest rates; asset/liability management reduces the likelihood of a mismatch.]

Factoring in Defined Benefit Pension Plans

A defined benefit pension plan provides a fixed, pre-established pension benefit for employees upon retirement, and the employer carries the risk that assets invested in the pension plan may not be sufficient to pay all benefits. Companies must forecast the dollar amount of assets available to pay benefits required by a defined benefit plan.

Assume, for example, that a group of employees must receive a total of $1.5 million in pension payments starting in 10 years. The company must estimate a rate of return on the dollars invested in the pension plan and determine how much the firm must contribute each year before the first payments begin in 10 years.

Examples of Interest Rate Risk

Asset/liability management is also used in banking. A bank must pay interest on deposits and also charge a rate of interest on loans. To manage these two variables, bankers track the net interest margin or the difference between the interest paid on deposits and interest earned on loans.

Assume, for example, that a bank earns an average rate of 6% on three-year loans and pays a 4% rate on three-year certificates of deposit. The interest rate margin the bank generates is 6% – 4% = 2%. Since banks are subject to interest rate risk, or the risk that interest rates increase, clients demand higher interest rates on their deposits to keep assets at the bank.

The Asset Coverage Ratio

An important ratio used in managing assets and liabilities is the asset coverage ratio which computes the value of assets available to pay a firm’s debts. The ratio is calculated as follows:


$\begin{aligned} &\text{Asset Coverage Ratio} = \frac{ ( \text{BVTA} – \text{IA} ) – ( \text{CL} – \text{STDO}) }{ \text{Total Debt Outstanding} } \\ &\textbf{where:} \\ &\text{BVTA} = \text{book value of total assets} \\ &\text{IA} = \text{intangible assets} \\ &\text{CL} = \text{current liabilities} \\ &\text{STDO} = \text{short term debt obligations} \\ \end{aligned}$​Asset Coverage Ratio=Total Debt Outstanding(BVTA−IA)−(CL−STDO)​where:BVTA=book value of total assetsIA=intangible assetsCL=current liabilitiesSTDO=short term debt obligations​

Tangible assets, such as equipment and machinery, are stated at their book value, which is the cost of the asset less accumulated depreciation. Intangible assets, such as patents, are subtracted from the formula because these assets are more difficult to value and sell. Debts payable in less than 12 months are considered short-term debt, and those liabilities are also subtracted from the formula.

The coverage ratio computes the assets available to pay debt obligations, although the liquidation value of some assets, such as real estate, may be difficult to calculate. There is no rule of thumb as to what constitutes a good or poor ratio since calculations vary by industry.

Key Takeaways

• Asset/liability management reduces the risk that a company may not meet its obligations in the future.
• The success of bank loan portfolios and pension plans depend on asset/liability management processes.
• Banks track the difference between the interest paid on deposits and interest earned on loans to ensure that they can pay interest on deposits and to determine what a rate of interest to charge on loans.

[Fast Fact: Asset/liability management is a long-term strategy to manage risks. For example, a home-owner must ensure that they have enough money to pay their mortgage each month by managing their income and expenses for the duration of the loan.]

What Is an Arm’s Length Transaction?

An arm’s length transaction refers to a business deal in which buyers and sellers act independently without one party influencing the other. Arm’s length transactions assert that both parties act in their own self-interest and are not subject to pressure from the other party. They also assure others that there is no collusion between the buyer and seller. In the interest of fairness, both parties usually have equal access to information related to the deal.

Understanding Arm’s Length Transactions

Arm’s length transactions are commonly used in real estate deals because the sale affects not only those who are directly involved in the deal but other parties as well, including lenders.

If two strangers are involved in the sale and purchase of a house, the final agreed-upon price is likely close to fair market value (FMV), assuming that both parties have equal bargaining power and the same information about the property. The seller would want a price that’s as high as possible, and the buyer would want a price that is as low as possible. Otherwise, the agreed-upon price is not likely to differ from the property’s actual FMV.

As noted above, the buyer and seller aren’t the only ones involved in an arm’s length transaction. This type of transaction also has a direct impact on the financing needed from a bank as well as municipal and local taxes. The transaction can also influence comparable prices in the market.

Arm’s Length vs. Non-Arm’s Length Transactions

Family members and companies with related shareholders generally don’t engage in arm’s length sales. Instead, the deals between them are non-arm’s length transactions. This type of transaction, which is also known as an arm-in-arm transaction, refers to a business deal in which buyers and sellers have an identity of interest. Put simply, buyers and sellers have an existing relationship that is either business-related or personal.

An existing relationship tends to influence the terms of a non-arm’s length transaction. For instance, it’s unlikely that a transaction involving a father and his son would yield the same result as a deal between strangers because the father may choose to give his son a discount.

If the sale of a house between father and son is taxable, tax authorities may require the seller to pay taxes on the gain he would have realized had he been selling to a neutral third party. They would disregard the actual price paid by the son.

In the same way, international sales between non-arm’s-length companies, such as two subsidiaries of the same parent company, must be made using arm’s length prices. This practice, known as transfer pricing, assures that each country collects the appropriate taxes on the transactions.

Arm’s Length Transactions and Fair Market Value (FMV)

As noted above, one of the main benefits of arm’s length transactions is that the transaction is fair and equitable. This is especially true when it comes to real estate deals. When the buyer and seller have no previous relationship, the terms of the deal—notably, the sale price—accurately reflect market conditions rather than being influenced by other factors. This value is referred to as the fair market value.

FMV is the best possible price that a neutral and impartial seller and buyer are willing to accept and pay to close the deal. The following are just some of the factors that are used to determine the FMV of a home:

• Location (city, neighborhood)
• Comparable home prices
• Condition and age of home
• Size and amenities
• Renovations and upgrades made to the property

Of course, other factors also work into the FMV of a home, including interest rates and the condition of the overall economy.

Example of an Arm’s Length Transaction

Let’s use a hypothetical example to show how arm’s length transactions work. We can start by expanding on the example above using the father and son and the real estate transaction. For clarity’s sake, let’s say the father’s name is John and the son’s name is Henry.

Assume that John is selling his home and puts the house up for sale for $350,000. He gets an offer for that amount based on the FMV. The potential buyer looked at some of the factors affecting the value, including the location, amenities, and comparable homes. If the sale goes through, it’s considered a arm’s length transaction.

But Henry throws John a loop saying he needs a new place and would like to buy the home for himself. He offers a lower price of $275,000 since it’s his father who’s selling the house. If John decides to accept, he would be conducting a non-arm’s length transaction.

The Bottom Line

Every buyer and seller wants to get the best price possible for their financial transactions. One of the best ways to do so is to conduct an arm’s length transaction. Being at arm’s length means there are no personal factors that influence the price and the decision to either accept or reject an offer. Those who execute non-arm’s length transactions may not get the best price, which can also affect the overall market and lending decisions.

What Is Asset Management?

Asset management is the practice of increasing total wealth over time by acquiring, maintaining, and trading investments that have the potential to grow in value.

Asset management professionals perform this service for others. They may also be called portfolio managers or financial advisors. Many work independently while others work for an investment bank or other financial institution.

Understanding Asset Management

Asset management has a double-barreled goal: increasing value while mitigating risk. That is, the client’s tolerance for risk is the first question to be posed. A retiree living on the income from a portfolio, or a pension fund administrator overseeing retirement funds, is (or should be) risk-averse. A young person, or any adventurous person, might want to dabble in high-risk investments.

Most of us are somewhere in the middle, and asset managers try to identify just where that is for a client.

The asset manager’s role is to determine what investments to make, or avoid, to realize the client’s financial goals within the limits of the client’s risk tolerance. The investments may include stocks, bonds, real estate, commodities, alternative investments, and mutual funds, among the better-known choices.

The asset manager is expected to conduct rigorous research using both macro and microanalytical tools. This includes statistical analysis of prevailing market trends, reviews of corporate financial documents, and anything else that would aid in achieving the stated goal of client asset appreciation.

Types of Asset Managers

There are several different types of asset managers, distinguished by the type of asset and level of service that they provide. Each type of asset manager has a different level of responsibility to the client, so it is important to understand a manager’s obligations before deciding to invest.

Registered Investment Advisers

A registered investment adviser (RIA) is a firm that advises clients on securities trades or even manages their portfolios. RIAs are closely regulated and are required to register with the SEC if they manage more than $100 million in assets.

Investment Broker

A broker is an individual or firm that acts as an intermediary for their clients, buying stocks and securities and providing custody over customer assets. Brokers generally do not have a fiduciary duty to their clients, so it is always important to thoroughly research before buying.

Financial Advisor

A financial advisor is a professional who can recommend investments to their clients, or buy and sell securities on their behalf. Financial advisors may or may not have a fiduciary duty to their clients, so it is always important to ask first. Many financial advisors specialize in a specific area, such as tax law or estate planning.

Robo-Advisor

The most affordable type of investment manager isn’t a person at all. A robo-advisor is a computer algorithm that automatically monitors and rebalances an investor’s portfolio according, selling and buying investments according to programmed goals and risk tolerances. Because there is no person involved, robo-advisors cost much less than a personalized investment service.

How Much Does Asset Management Cost?

Asset managers have a variety of fee structures. The most common model charges a percentage of the assets under management, with the industry average at about 1% for up to $1 million, and lower for larger portfolios. Others may charge a fee for each trade they execute. Some may even receive a commission to upsell securities to their clients.

Because these incentives can work against the client’s interests, it is important to know if your management firm has a fiduciary duty to serve the client’s interests. Otherwise, they may recommend investments or trades that do not serve the client’s interests.

How Asset Management Companies Work

Asset management companies compete to serve the investment needs of high-net-worth individuals and institutions.

Accounts held by financial institutions often include check-writing privileges, credit cards, debit cards, margin loans, and brokerage services.

When individuals deposit money into their accounts, it is typically placed into a money market fund that offers a greater return than a regular savings account. Account-holders can choose between Federal Deposit Insurance Company-backed (FDIC) funds and non-FDIC funds.

The added benefit to account holders is all of their banking and investing needs can be met by the same institution.

These types of accounts have only been possible since the passage of the Gramm-Leach-Bliley Act in 1999, which replaced the Glass-Steagall Act. The Glass-Steagall Act of 1933, passed during the Great Depression, forced a separation between banking and investing services. Now, they have only to maintain a “Chinese wall” between divisions.

Example of an Asset Management Institution

Merrill Lynch offers a Cash Management Account (CMA) to fulfill the needs of clients who wish to pursue banking and investment options with one vehicle, under one roof.

The account gives investors access to a personal financial advisor. This advisor offers advice and a range of investment options that include initial public offerings (IPO) in which Merrill Lynch may participate, as well as foreign currency transactions.

Interest rates for cash deposits are tiered. Deposit accounts can be linked together so that all eligible funds aggregate to receive the appropriate rate. Securities held in the account fall under the protective umbrella of the Securities Investor Protection Corporation (SIPC). SIPC does not shield investor assets from inherent risk but rather protects those assets from the financial failure of the brokerage firm itself.

Along with typical check writing services, the account offers worldwide access to Bank of America automated teller machines (ATM) without transaction fees. Bill payment services, fund transfers, and wire transfers are available. The MyMerrill app allows users to access the account and perform a number of basic functions via a mobile device.

Accounts with more than $250,000 in eligible assets sidestep both the annual $125 fee and the $25 assessment applied to each sub-account held.

Frequently Asked Questions

The Bottom Line

Asset management firms provide the service of buying and selling assets on behalf of their clients. There are many types of asset managers, with some working for family offices and wealthy individuals and others working on behalf of major banks and institutional investors.

What Is Antitrust?

Antitrust laws are regulations that encourage competition by limiting the market power of any particular firm. This often involves ensuring that mergers and acquisitions don’t overly concentrate market power or form monopolies, as well as breaking up firms that have become monopolies.

Antitrust laws also prevent multiple firms from colluding or forming a cartel to limit competition through practices such as price fixing. Due to the complexity of deciding what practices will limit competition, antitrust law has become a distinct legal specialization.

Understanding Antitrust

Antitrust laws are the broad group of state and federal laws that are designed to make sure businesses are competing fairly. The “trust” in antitrust refers to a group of businesses that team up or form a monopoly to dictate pricing in a particular market.

Supporters say antitrust laws are necessary and that competition among sellers gives consumers lower prices, higher-quality products and services, more choices, and greater innovation. Most people agree with this concept and the benefits of an open marketplace, although there are some who claim that allowing businesses to compete as they see fit would ultimately give consumers the best prices.

The Antitrust Laws

The Sherman Act, the Federal Trade Commission Act, and the Clayton Act are the key laws that set the groundwork for antitrust regulation. Predating the Sherman Act, the Interstate Commerce Act was also beneficial in establishing antitrust regulations, although it was less influential than some of the others.

Congress passed the Interstate Commerce Act in 1887 in response to growing public demand that railroads be regulated. Among other requirements, the law ordered railroads to charge a fair fee to travelers and post those fees publicly. It was the first example of antitrust law but was less influential than the Sherman Act, passed in 1890.

The Sherman Act outlawed contracts and conspiracies restraining trade and/or monopolizing industries in an attempt to stop competing individuals or businesses fixing prices, dividing markets, or attempting to rig bids. The Sherman Act laid out specific penalties and fines for violating the terms.

In 1914, Congress passed the Federal Trade Commission Act, banning unfair competition methods and deceptive acts or practices. The Clayton Act was also passed in 1914, addressing specific practices that the Sherman Act does not ban. For example, the Clayton Act prohibits appointing the same person to make business decisions for competing corporations.

Special Considerations

The Federal Trade Commission (FTC) and the U.S. Department of Justice (DOJ) are tasked with enforcing federal antitrust laws. In some cases, these two authorities may also work with other regulatory agencies to ensure that certain mergers fit the public interest.

The FTC mainly focuses on segments of the economy where consumer spending is high, including healthcare, drugs, food, energy, technology, and anything related to digital communications. Factors that could spark an FTC investigation include premerger notification filings, certain consumer or business correspondence, congressional inquiries, or articles on consumer or economic subjects.

If the FTC thinks that a law has been violated, the agency will try to stop the questionable practices or find a resolution to the anticompetitive portion of, say, a proposed merger between two competitors. If no resolution is found, the FTC may put out an administrative complaint and/or pursue injunctive relief in federal court.

The FTC might also refer evidence of criminal antitrust violations to the DOJ. The DOJ has the power to impose criminal sanctions and holds sole antitrust jurisdiction in certain sectors, such as telecommunications, banks, railroads, and airlines.

Major Example of Antitrust Law

In January 2023, the DOJ and eight states filed an antitrust lawsuit against Alphabet’s Google, alleging that the search giant has illegal monopolization of the digital advertising business. “Today’s complaint alleges that Google has used anticompetitive, exclusionary, and unlawful conduct to eliminate or severely diminish any threat to its dominance over digital advertising technologies,” the government agency said.

The filing, which seeks to make Google divest parts of its advertising business, alleges that the company has used acquisitions as a strategy for “neutralizing or eliminating” rivals and forces advertisers to use its products by making competitors’ products difficult to use. The complaint claims that the company’s monopolistic practices curtail innovation, raise advertising fees, and prevent small businesses and publishers from growing.

Google’s advertising business has come under fire from critics who argue that the search giant controls both the supply and demand sides of the digital advertising market. The company provides tools that help websites offer ad space and that assist advertisers in placing online ads. The suit alleges that Google’s dominance in the market allows it to pocket 30 cents of each dollar that advertisers spend using its suite of advertising tools.

The lawsuit marks the second federal antitrust complaint against Google in three years. Under the former Trump administration, the DOJ filed a lawsuit in October 2020, accusing the tech giant of using its monopoly to reduce competition through exclusionary agreements. That case is expected to go to trial this fall.

Google responded to the suit, saying the DOJ was attempting to intervene in the free market. “Today’s lawsuit from the Department of Justice attempts to pick winners and losers in the highly competitive advertising technology sector,” Google Global Ads Vice President Dan Taylor said in a statement.

The Bottom Line

Antitrust laws regulate the concentration of economic power to prevent companies from price colluding or creating monopolies. Proponents of antitrust laws argue that they keep consumer prices lower and foster innovation through increased competition. Critics say antitrust regulations intervene in the free market and reduce efficiency.

Antitrust laws are enforced by the FTC and DOJ, with the agencies focusing on areas of the economy that receive significant consumer spending, such as technology, healthcare, pharmaceuticals, and communications. Typically, antitrust investigations arise from premerger notification filings, congressional inquiries, or consumer and business correspondence.