Financial Institutions Management: A Risk Management Approach

Title
Contents
PART ONE INTRODUCTION
	Chapter One Why Are Financial Institutions Special?
		Introduction
		Financial Institutions’ Specialness
		FIs Function as Brokers
		FIs Function as Asset Transformers
		Information Costs
		Liquidity and Price Risk
		Other Special Services
		Other Aspects of Specialness
		The Transmission of Monetary Policy
		Credit Allocation
		Intergenerational Wealth Transfers or Time Intermediation
		Payment Services
		Denomination Intermediation
		Specialness and Regulation
		Safety and Soundness Regulation
		Monetary Policy Regulation
		Credit Allocation Regulation
		Consumer Protection Regulation
		Investor Protection Regulation
		Entry Regulation
		The Changing Dynamics of Specialness
		Trends in the United States
		Global Trends
		Summary
		Appendix 1A The Financial Crisis: The Failure of Financial Services Institution Specialness
		Appendix 1B Monetary Policy Tools
	Chapter Two Financial Services: Depository Institutions
		Introduction
		Commercial Banks
		Size, Structure, and Composition of the Industry
		Balance Sheet and Recent Trends
		Other Fee-Generating Activities
		Regulation
		Industry Performance
		Savings Institutions
		Size, Structure, and Composition of the Industry
		Balance Sheet and Recent Trends
		Regulation
		Industry Performance
		Credit Unions
		Size, Structure, and Composition of the Industry
		Balance Sheet and Recent Trends
		Regulation
		Industry Performance
		Global Issues: The Financial Crisis
		Summary
		Appendix 2A Financial Statement Analysis Using a Return on Equity (ROE) Framework
		Appendix 2B Commercial Banks’ Financial Statements and Analysis
		Appendix 2C Depository Institutions and Their Regulators
		Appendix 2D Technology in Commercial Banking
	Chapter Three Financial Services: Insurance
		Introduction
		Life Insurance
		Size, Structure, and Composition of the Industry
		Balance Sheet and Recent Trends
		Regulation
		Property–Casualty Insurance
		Size, Structure, and Composition of the Industry
		Balance Sheet and Recent Trends
		Regulation
		Global Issues
		Summary
		Chapter Four Financial Services: Securities Brokerage and Investment Banking
		Introduction
		Size, Structure, and Composition of the Industry
		Balance Sheet and Recent Trends
		Recent Trends
		Balance Sheet
		Regulation
		Global Issues
		Summary
	Chapter Five Financial Services: Mutual Funds and Hedge Funds
		Introduction
		Size, Structure, and Composition of the Mutual Fund Industry
		Historical Trends
		Different Types of Mutual Funds
		Mutual Fund Objectives
		Investor Returns from Mutual Fund Ownership
		Mutual Fund Costs
		Balance Sheet and Recent Trends for the Mutual Fund Industry
		Money Market Funds
		Long-Term Funds
		Regulation of Mutual Funds
		Global Issues in the Mutual Fund Industry
		Hedge Funds
		Types of Hedge Funds
		Fees on Hedge Funds
		Offshore Hedge Funds
		Regulation of Hedge Funds
		Summary
	Chapter Six Financial Services: Finance Companies
		Introduction
		Size, Structure, and Composition of the Industry
		Balance Sheet and Recent Trends
		Assets
		Liabilities and Equity
		Industry Performance
		Regulation
		Global Issues
		Summary
	Chapter Seven Risks of Financial Institutions
		Introduction
		Interest Rate Risk
		Market Risk
		Credit Risk
		Off-Balance-Sheet Risk
		Foreign Exchange Risk
		Country or Sovereign Risk
		Technology and Operational Risks
		Liquidity Risk
		Insolvency Risk
		Other Risks and the Interaction of Risks
		Summary
PART TWO MEASURING RISK
	Chapter Eight Interest Rate Risk I
		Introduction
		The Level and Movement of Interest Rates
		The Repricing Model
		Rate-Sensitive Assets
		Rate-Sensitive Liabilities
		Equal Changes in Rates on RSAs and RSLs
		Unequal Changes in Rates on RSAs and RSLs
		Weaknesses of the Repricing Model
		Market Value Effects
		Overaggregation
		The Problem of Runoffs
		Cash Flows from Off-Balance-Sheet Activities
		Summary
		Appendix 8A The Maturity Model
		Appendix 8B Term Structure of Interest Rates
	Chapter Nine Interest Rate Risk II
		Introduction
		Duration: A Simple Introduction
		A General Formula for Duration
		The Duration of Interest-Bearing Bonds
		The Duration of a Zero-Coupon Bond
		The Duration of a Consol Bond (Perpetuities)
		Features of Duration
		Duration and Maturity
		Duration and Yield
		Duration and Coupon Interest
		The Economic Meaning of Duration
		Semiannual Coupon Bonds
		Duration and Interest Rate Risk
		Duration and Interest Rate Risk Management on a Single Security
		Duration and Interest Rate Risk Management on the Whole Balance Sheet of an FI
		Immunization and Regulatory Considerations
		Difficulties in Applying the Duration Model
		Duration Matching Can Be Costly
		Immunization Is a Dynamic Problem
		Large Interest Rate Changes and Convexity
		Summary
		Appendix 9A The Basics of Bond Valuation
		Appendix 9B Incorporating Convexity into the Duration Model
	Chapter Ten Market Risk
		Introduction
		Calculating Market Risk Exposure
		The RiskMetrics Model
		The Market Risk of Fixed-Income Securities
		Foreign Exchange
		Equities
		Portfolio Aggregation
		Historic (Back Simulation) Approach
		The Historic (Back Simulation) Model versus RiskMetrics
		The Monte Carlo Simulation Approach
		Regulatory Models: The BIS Standardized Framework
		Fixed Income
		Foreign Exchange
		Equities
		The BIS Regulations and Large-Bank Internal Models
		Summary
	Chapter Eleven Credit Risk: Individual Loan Risk
		Introduction
		Credit Quality Problems
		Types of Loans
		Commercial and Industrial Loans
		Real Estate Loans
		Individual (Consumer) Loans
		Other Loans
		Calculating the Return on a Loan
		The Contractually Promised Return on a Loan
		The Expected Return on a Loan
		Retail versus Wholesale Credit Decisions
		Retail
		Wholesale
		Measurement of Credit Risk
		Default Risk Models
		Qualitative Models
		Quantitative Models
		Newer Models of Credit Risk Measurement and Pricing
		Summary
		Appendix 11A Credit Analysis
		Appendix 11B Black-Scholes Option Pricing Model
	Chapter Twelve Credit Risk: Loan Portfolio and Concentration Risk
		Introduction
		Simple Models of Loan Concentration Risk
		Loan Portfolio Diversification and Modern Portfolio Theory (MPT)
		Moody’s KMV Portfolio Manager Model
		Partial Applications of Portfolio Theory
		Regulatory Models
		Summary
		Appendix 12A CreditMetrics
		Appendix 12B CreditRisk+
	Chapter Thirteen Off-Balance-Sheet Risk
		Introduction
		Off-Balance-Sheet Activities and FI Solvency
		Returns and Risks of Off-Balance-Sheet Activities
		Loan Commitments
		Commercial Letters of Credit and Standby Letters of Credit
		Derivative Contracts: Futures, Forwards, Swaps, and Options
		Forward Purchases and Sales of When-Issued Securities
		Loans Sold
		Non–Schedule L Off-Balance-Sheet Risks
		Settlement Risk
		Affiliate Risk
		The Role of OBS Activities in Reducing Risk
		Summary
		Appendix 13A A Letter of Credit Transaction
	Chapter Fourteen Foreign Exchange Risk
		Introduction
		Foreign Exchange Rates and Transactions
		Foreign Exchange Rates
		Foreign Exchange Transactions
		Sources of Foreign Exchange Risk Exposure
		Foreign Exchange Rate Volatility and FX Exposure
		Foreign Currency Trading
		FX Trading Activities
		Foreign Asset and Liability Positions
		The Return and Risk of Foreign Investments
		Risk and Hedging
		Multicurrency Foreign Asset–Liability Positions
		Interaction of Interest Rates, Inflation, and Exchange Rates
		Purchasing Power Parity
		Interest Rate Parity Theorem
		Summary
	Chapter Fifteen Sovereign Risk
		Introduction
		Credit Risk versus Sovereign Risk
		Debt Repudiation versus Debt Rescheduling
		Country Risk Evaluation
		Outside Evaluation Models
		Internal Evaluation Models
		Using Market Data to Measure Risk: The Secondary Market for LDC Debt
		Summary
		Appendix 15A Mechanisms for Dealing with Sovereign Risk Exposure
	Chapter Sixteen Technology and Other Operational Risks
		Introduction
		What Are the Sources of Operational Risk?
		Technological Innovation and Profitability
		The Impact of Technology on Wholesale and Retail Financial Service Production
		Wholesale Financial Services
		Retail Financial Services
		The Effect of Technology on Revenues and Costs
		Technology and Revenues
		Technology and Costs
		Testing for Economies of Scale and Economies of Scope
		The Production Approach
		The Intermediation Approach
		Empirical Findings on Cost Economies of Scale and Scope and Implications for Technology Expenditures
		Economies of Scale and Scope and X-Inefficiencies
		Technology and the Evolution of the Payments System
		Risks That Arise in an Electronic Transfer Payment System
		Other Operational Risks
		Regulatory Issues and Technology and Operational Risks
		Summary
	Chapter Seventeen Liquidity Risk
		Introduction
		Causes of Liquidity Risk
		Liquidity Risk at Depository Institutions
		Liability-Side Liquidity Risk
		Asset-Side Liquidity Risk
		Measuring a DI’s Liquidity Exposure
		Liquidity Risk, Unexpected Deposit Drains, and Bank Runs
		Bank Runs, the Discount Window, and Deposit Insurance
		Liquidity Risk and Life Insurance Companies
		Liquidity Risk and Property–Casualty Insurers
		Investment Funds
		Summary
		Appendix 17A Sources and Uses of Funds Statement, Bank of America, June 2009
PART THREE MANAGING RISK
	Chapter Eighteen Liability and Liquidity Management
		Introduction
		Liquid Asset Management
		Monetary Policy Implementation Reasons
		Taxation Reasons
		The Composition of the Liquid Asset Portfolio
		Return-Risk Trade-Off for Liquid Assets
		The Liquid Asset Reserve Management Problem for U.S. Depository Institutions
		Undershooting/Overshooting of the Reserve Target
		Managing Liquid Assets Other than Cash
		Liability Management
		Funding Risk and Cost
		Choice of Liability Structure
		Demand Deposits
		Interest-Bearing Checking (NOW) Accounts
		Passbook Savings
		Money Market Deposit Accounts (MMDAs)
		Retail Time Deposits and CDs
		Wholesale CDs
		Federal Funds
		Repurchase Agreements (RPs)
		Other Borrowings
		Liquidity and Liability Structures for U.S. Depository Institutions
		Liability and Liquidity Risk Management in Insurance Companies
		Liability and Liquidity Risk Management in Other FIs
		Summary
		Appendix 18A Federal Reserve Requirement Accounting
		Appendix 18B Bankers Acceptance and Commercial Paper as Sources of Financing
	Chapter Nineteen Deposit Insurance and Other Liability Guarantees
		Introduction
		Bank and Thrift Guaranty Funds
		The Causes of the Depository Fund Insolvencies
		The Financial Environment
		Moral Hazard
		Panic Prevention versus Moral Hazard
		Controlling Depository Institution Risk Taking
		Stockholder Discipline
		Depositor Discipline
		Regulatory Discipline
		Non-U.S. Deposit Insurance Systems
		The Discount Window
		Deposit Insurance versus the Discount Window
		The Discount Window
		Other Guaranty Programs
		National Credit Union Administration
		Property–Casualty and Life Insurance Companies
		The Securities Investor Protection Corporation
		The Pension Benefit Guaranty Corporation
		Summary
		Appendix 19A Calculation of Deposit Insurance Premiums
		Appendix 19B FDIC Press Release of Bank Failures
		Appendix 19C Deposit Insurance Coverage for Commercial Banks in Various Countries
	Chapter Twenty Capital Adequacy
		Introduction
		Capital and Insolvency Risk
		Capital
		The Market Value of Capital
		The Book Value of Capital
		The Discrepancy between the Market and Book Values of Equity
		Arguments against Market Value Accounting
		Capital Adequacy in the Commercial Banking and Thrift Industry
		Actual Capital Rules
		The Capital–Assets Ratio (or Leverage Ratio)
		Risk-Based Capital Ratios
		Calculating Risk-Based Capital Ratios
		Capital Requirements for Other FIs
		Securities Firms
		Life Insurance
		Property–Casualty Insurance
		Summary
		Appendix 20A Internal Ratings–Based Approach to Measuring Credit Risk–Adjusted Assets
	Chapter Twenty-One Product and Geographic Expansion
		Introduction
		Product Diversification
		Segmentation in the U.S. Financial Services Industry
		Commercial and Investment Banking Activities
		Banking and Insurance
		Commercial Banking and Commerce
		Nonbank Financial Service Firms and Commerce
		Activity Restrictions in the United States versus Other Countries
		Issues Involved in the Diversification of Product Offerings
		Safety and Soundness Concerns
		Economies of Scale and Scope
		Conflicts of Interest
		Deposit Insurance
		Regulatory Oversight
		Competition
		Domestic Geographic Expansion
		Regulatory Factors Impacting Geographic Expansion
		Insurance Companies
		Thrifts
		Commercial Banks
		Cost and Revenue Synergies Impacting Domestic Geographic Expansion by Merger and Acquisition
		Cost Synergies
		Revenue Synergies
		Merger Guidelines for Acceptability
		Other Market- and Firm-Specific Factors Impacting Domestic Geographic Expansion Decisions
		Global and International Expansions
		U.S. Banks Abroad
		Foreign Banks in the United States
		Advantages and Disadvantages of International Expansion
		Advantages
		Disadvantages
		Summary
		Appendix 21A EU and G-10 Countries: Regulatory Treatment of the Mixing of Banking, Securities, and Insurance Activities and the Mixing of Banking and Commerce
	Chapter Twenty-Two Futures and Forwards
		Introduction
		Forward and Futures Contracts
		Spot Contracts
		Forward Contracts
		Futures Contracts
		Forward Contracts and Hedging Interest Rate Risk
		Hedging Interest Rate Risk with Futures Contracts
		Microhedging
		Macrohedging
		Routine Hedging versus Selective Hedging
		Macrohedging with Futures
		The Problem of Basis Risk
		Hedging Foreign Exchange Risk
		Forwards
		Futures
		Estimating the Hedge Ratio
		Hedging Credit Risk with Futures and Forwards
		Credit Forward Contracts and Credit Risk Hedging
		Futures Contracts and Catastrophe Risk
		Regulation of Derivative Securities
		Summary
		Appendix 22A Microhedging with Futures
	Chapter Twenty-Three Options, Caps, Floors, and Collars
		Introduction
		Basic Features of Options
		Buying a Call Option on a Bond
		Writing a Call Option on a Bond
		Buying a Put Option on a Bond
		Writing a Put Option on a Bond
		Writing versus Buying Options
		Economic Reasons for Not Writing Options
		Regulatory Reasons
		Futures versus Options Hedging
		The Mechanics of Hedging a Bond or Bond Portfolio
		Hedging with Bond Options Using the Binomial Model
		Actual Bond Options
		Using Options to Hedge Interest Rate Risk on the Balance Sheet
		Using Options to Hedge Foreign Exchange Risk
		Hedging Credit Risk with Options
		Hedging Catastrophe Risk with Call Spread Options
		Caps, Floors, and Collars
		Caps
		Floors
		Collars
		Caps, Floors, Collars, and Credit Risk
		Summary
		Appendix 23A Black-Scholes Option Pricing Model
		Appendix 23B Microhedging with Options
	Chapter Twenty-Four Swaps
		Introduction
		Swap Markets
		Interest Rate Swaps
		Realized Cash Flows on an Interest Rate Swap
		Macrohedging with Swaps
		Currency Swaps
		Fixed-Fixed Currency Swaps
		Fixed-Floating Currency Swaps
		Credit Swaps
		Total Return Swaps
		Pure Credit Swaps
		Swaps and Credit Risk Concerns
		Netting and Swaps
		Payment Flows Are Interest and Not Principal
		Standby Letters of Credit
		Summary
		Appendix 24A Setting Rates on an Interest Rate Swap
	Chapter Twenty-Five Loan Sales
		Introduction
		The Bank Loan Sales Market
		Definition of a Loan Sale
		Types of Loan Sales
		Types of Loan Sales Contracts
		Trends in Loan Sales
		The Buyers and the Sellers
		Why Banks and Other FIs Sell Loans
		Reserve Requirements
		Fee Income
		Capital Costs
		Liquidity Risk
		Factors Affecting Loan Sales Growth
		Access to the Commercial Paper Market
		Customer Relationship Effects
		Legal Concerns
		BIS Capital Requirements
		Market Value Accounting
		Asset Brokerage and Loan Trading
		Government Loan Sales
		Credit Ratings
		Purchase and Sale of Foreign Bank Loans
		Summary
	Chapter Twenty-Six Securitization
		Introduction
		Mechanisms Used to Convert On-Balance-Sheet Assets to a Securitized Asset
		The Pass-Through Security
		GNMA
		FNMA
		FHLMC
		The Incentives and Mechanics of Pass-Through Security Creation
		Prepayment Risk on Pass-Through Securities
		Prepayment Models
		Government Sponsorship and Oversight of FNMA and Freddie Mac
		The Collateralized Mortgage Obligation (CMO)
		Creation of CMOs
		Class A, B, and C Bond Buyers
		Other CMO Classes
		The Mortgage-Backed Bond (MBB)
		Innovations in Securitization
		Mortgage Pass-Through Strips
		Securitization of Other Assets
		Can All Assets Be Securitized?
		Summary
Appendix 26A Fannie Mae and Freddie Mac Balance Sheets
INDEX