Financial Markets and Institutions, 7th Edition (The Prentice Hall Series in Finance)

Cover......Page 1
Title Page......Page 4
Copyright Page......Page 5
Contents......Page 10
Contents on the Web......Page 28
What’s New in the Seventh Edition......Page 30
Hallmarks......Page 34
Making It Easier to Teach Financial Markets and Institutions......Page 35
Pedagogical Aids......Page 36
Supplementary Materials......Page 37
Acknowledgments......Page 38
About the Authors......Page 40
Preview......Page 42
Why Study Financial Markets?......Page 43
Why Study Financial Institutions?......Page 47
How We Will Study Financial Markets and Institutions......Page 49
Web Exercise......Page 51
Summary......Page 53
Questions......Page 54
Web Exercises......Page 55
Preview......Page 56
Function of Financial Markets......Page 57
Structure of Financial Markets......Page 59
Internationalization of Financial Markets......Page 61
GLOBAL: Are U.S. Capital Markets Losing Their Edge?......Page 62
Function of Financial Intermediaries: Indirect Finance......Page 63
FOLLOWING THE FINANCIAL NEWS: Foreign Stock Market Indexes......Page 64
GLOBAL: The Importance of Financial Intermediaries Relative to Securities Markets: An International Comparison......Page 65
Types of Financial Intermediaries......Page 68
Regulation of the Financial System......Page 71
Summary......Page 74
Questions......Page 75
Web Exercises......Page 76
Preview......Page 77
Measuring Interest Rates......Page 78
GLOBAL: Negative T-Bill Rates? It Can Happen......Page 88
The Distinction Between Real and Nominal Interest Rates......Page 89
The Distinction Between Interest Rates and Returns......Page 91
MINI-CASE: With TIPS, Real Interest Rates Have Become Observable in the United States......Page 92
MINI-CASE: Helping Investors Select Desired Interest-Rate Risk......Page 95
THE PRACTICING MANAGER: Calculating Duration to Measure Interest-Rate Risk......Page 96
Summary......Page 102
Quantitative Problems......Page 103
Web Exercises......Page 104
Determinants of Asset Demand......Page 105
Supply and Demand in the Bond Market......Page 109
Changes in Equilibrium Interest Rates......Page 113
CASE: Changes in the Interest Rate Due to Expected Inflation: The Fisher Effect......Page 119
CASE: Changes in the Interest Rate Due to a Business Cycle Expansion......Page 120
CASE: Explaining Low Japanese Interest Rates......Page 122
CASE: Reading the Wall Street Journal "Credit Markets" Column......Page 123
FOLLOWING THE FINANCIAL NEWS: The "Credit Markets" Column......Page 124
THE PRACTICING MANAGER: Profiting from Interest-Rate Forecasts......Page 125
Summary......Page 126
Questions......Page 127
Web Exercises......Page 128
Web Appendices......Page 129
Risk Structure of Interest Rates......Page 130
CASE: The Subprime Collapse and the Baa-Treasury Spread......Page 134
Term Structure of Interest Rates......Page 137
FOLLOWING THE FINANCIAL NEWS: Yield Curves......Page 138
CASE: Interpreting Yield Curves, 1980–2010......Page 149
THE PRACTICING MANAGER: Using the Term Structure to Forecast Interest Rates......Page 151
Summary......Page 153
Questions......Page 154
Quantitative Problems......Page 155
Web Exercises......Page 156
Preview......Page 157
The Efficient Market Hypothesis......Page 158
Evidence on the Efficient Market Hypothesis......Page 161
MINI-CASE: An Exception That Proves the Rule: Ivan Boesky......Page 163
CASE: Should Foreign Exchange Rates Follow a Random Walk?......Page 165
Overview of the Evidence on the Efficient Market Hypothesis......Page 167
MINI-CASE: Should You Hire an Ape as Your Investment Adviser?......Page 168
CASE: What Do the Black Monday Crash of 1987 and the Tech Crash of 2000 Tell Us About the Efficient Market Hypothesis?......Page 171
Behavioral Finance......Page 172
Questions......Page 173
Web Exercises......Page 174
Basic Facts About Financial Structure Throughout the World......Page 175
Transaction Costs......Page 179
Asymmetric Information: Adverse Selection and Moral Hazard......Page 180
The Lemons Problem: How Adverse Selection Influences Financial Structure......Page 181
MINI-CASE: The Enron Implosion......Page 184
How Moral Hazard Affects the Choice Between Debt and Equity Contracts......Page 186
How Moral Hazard Influences Financial Structure in Debt Markets......Page 189
CASE: Financial Development and Economic Growth......Page 193
MINI-CASE: Should We Kill All the Lawyers?......Page 194
Conflicts of Interest......Page 195
MINI-CASE: The Demise of Arthur Andersen......Page 198
MINI-CASE: Credit Rating Agencies and the 2007–2009 Financial Crisis......Page 199
Summary......Page 201
Questions......Page 202
Web Exercises......Page 203
Preview......Page 204
Dynamics of Financial Crises in Advanced Economies......Page 205
CASE: The Mother of All Financial Crises: The Great Depression......Page 210
CASE: The 2007–2009 Financial Crisis......Page 212
INSIDE THE FED: Was the Fed to Blame for the Housing Price Bubble?......Page 215
GLOBAL: Ireland and the 2007–2009 Financial Crisis......Page 218
Dynamics of Financial Crises in Emerging Market Economies......Page 219
CASE: Financial Crises in Mexico, 1994–1995; East Asia, 1997–1998; and Argentina, 2001–2002......Page 225
GLOBAL: The Perversion of the Financial Liberalization/Globalization Process: Chaebols and the South Korean Crisis......Page 226
Summary......Page 229
Questions......Page 230
Web References......Page 231
Preview......Page 232
INSIDE THE FED: The Political Genius of the Founders of the Federal Reserve System......Page 233
Structure of the Federal Reserve System......Page 234
INSIDE THE FED: The Special Role of the Federal Reserve Bank of New York......Page 236
INSIDE THE FED: The Role of the Research Staff......Page 239
INSIDE THE FED: Green, Blue, Teal, and Beige: What Do These Colors Mean at the Fed?......Page 241
INSIDE THE FED: How Bernanke's Style Differs from Greenspan's......Page 242
How Independent Is the Fed?......Page 243
Structure and Independence of the European Central Bank......Page 244
Structure and Independence of Other Foreign Central Banks......Page 247
Explaining Central Bank Behavior......Page 248
Should the Fed Be Independent?......Page 249
INSIDE THE FED: The Evolution of the Fed's Communication Strategy......Page 250
Questions and Problems......Page 253
Web Exercises......Page 254
The Federal Reserve's Balance Sheet......Page 255
The Market for Reserves and the Federal Funds Rate......Page 258
INSIDE THE FED: Why Does the Fed Need to Pay Interest on Reserves?......Page 261
CASE: How the Federal Reserve's Operating Procedures Limit Fluctuations in the Federal Funds Rate......Page 264
Tools of Monetary Policy......Page 265
Discount Policy......Page 267
Reserve Requirements......Page 269
INSIDE THE FED: Federal Reserve Lender-of-Last-Resort Facilities During the 2007–2009 Financial Crisis......Page 270
Monetary Policy Tools of the European Central Bank......Page 271
The Price Stability Goal and the Nominal Anchor......Page 273
Other Goals of Monetary Policy......Page 274
Should Price Stability Be the Primary Goal of Monetary Policy?......Page 276
Inflation Targeting......Page 278
Disadvantages of Inflation Targeting......Page 281
INSIDE THE FED: Chairman Bernanke and Inflation Targeting......Page 283
Central Banks' Response to Asset-Price Bubbles: Lessons from the 2007–2009 Financial Crisis......Page 284
Tactics: Choosing the Policy Instrument......Page 287
THE PRACTICING MANAGER: Using a Fed Watcher......Page 290
Summary......Page 291
Questions......Page 292
Web Exercises......Page 293
Web Appendices......Page 294
Preview......Page 295
The Money Markets Defined......Page 296
The Purpose of the Money Markets......Page 298
Who Participates in the Money Markets?......Page 299
Money Market Instruments......Page 301
CASE: Discounting the Price of Treasury Securities to Pay the Interest......Page 302
MINI-CASE: Treasury Bill Auctions Go Haywire......Page 305
GLOBAL: Ironic Birth of the Eurodollar Market......Page 313
Comparing Money Market Securities......Page 314
FOLLOWING THE FINANCIAL NEWS: Money Market Rates......Page 315
Summary......Page 317
Quantitative Problems......Page 318
Web Exercises......Page 319
Purpose of the Capital Market......Page 320
Capital Market Trading......Page 321
Types of Bonds......Page 322
Treasury Notes and Bonds......Page 323
CASE: The 2007–2009 Financial Crisis and the Bailout of Fannie Mae and Freddie Mac......Page 325
Municipal Bonds......Page 327
Corporate Bonds......Page 329
Financial Guarantees for Bonds......Page 334
Current Yield Calculation......Page 335
Finding the Value of Coupon Bonds......Page 336
Investing in Bonds......Page 339
Summary......Page 340
Quantitative Problems......Page 341
Web Exercises......Page 342
Investing in Stocks......Page 343
Computing the Price of Common Stock......Page 348
How the Market Sets Security Prices......Page 352
Errors in Valuation......Page 354
CASE: The 2007–2009 Financial Crisis and the Stock Market......Page 355
CASE: The September 11 Terrorist Attack, the Enron Scandal, and the Stock Market......Page 356
Stock Market Indexes......Page 357
Buying Foreign Stocks......Page 359
Regulation of the Stock Market......Page 360
Key Terms......Page 361
Quantitative Problems......Page 362
Web Exercises......Page 363
Preview......Page 364
What Are Mortgages?......Page 365
Characteristics of the Residential Mortgage......Page 366
CASE: The Discount Point Decision......Page 367
Types of Mortgage Loans......Page 371
Mortgage-Lending Institutions......Page 374
Loan Servicing......Page 375
Secondary Mortgage Market......Page 376
Securitization of Mortgages......Page 377
Key Terms......Page 381
Quantitative Problems......Page 382
Web Exercises......Page 384
Preview......Page 385
Foreign Exchange Market......Page 386
FOLLOWING THE FINANCIAL NEWS: Foreign Exchange Rates......Page 388
Exchange Rates in the Long Run......Page 389
Exchange Rates in the Short Run: A Supply and Demand Analysis......Page 393
Explaining Changes in Exchange Rates......Page 396
CASE: Changes in the Equilibrium Exchange Rate: An Example......Page 401
CASE: The Dollar and Interest Rates......Page 403
CASE: The Subprime Crisis and the Dollar......Page 405
CASE: Reading the Wall Street Journal: The "Currency Trading" Column......Page 406
THE PRACTICING MANAGER: Profiting from Foreign Exchange Forecasts......Page 407
Summary......Page 408
Quantitative Problems......Page 409
Web Exercises......Page 410
Comparing Expected Returns on Domestic and Foreign Assets......Page 411
Interest Parity Condition......Page 413
Intervention in the Foreign Exchange Market......Page 415
INSIDE THE FED: A Day at the Federal Reserve Bank of New York's Foreign Exchange Desk......Page 417
Balance of Payments......Page 420
Exchange Rate Regimes in the International Financial System......Page 421
GLOBAL: The Euro's Challenge to the Dollar......Page 424
GLOBAL: Argentina's Currency Board......Page 425
GLOBAL: Dollarization......Page 426
CASE: The Foreign Exchange Crisis of September 1992......Page 427
THE PRACTICING MANAGER: Profiting from a Foreign Exchange Crisis......Page 428
CASE: Recent Foreign Exchange Crises in Emerging Market Countries: Mexico 1994, East Asia 1997, Brazil 1999, and Argentina 2002......Page 429
CASE: How Did China Accumulate Over $2 Trillion of International Reserves?......Page 430
Capital Controls......Page 432
The Role of the IMF......Page 433
Key Terms......Page 436
Quantitative Problems......Page 437
Web Appendices......Page 438
Preview......Page 439
The Bank Balance Sheet......Page 440
Basic Banking......Page 444
General Principles of Bank Management......Page 446
THE PRACTICING MANAGER: Strategies for Managing Bank Capital......Page 453
CASE: How a Capital Crunch Caused a Credit Crunch in 2008......Page 454
Off-Balance-Sheet Activities......Page 455
CONFLICTS OF INTEREST: Barings, Daiwa, Sumitomo, and Societé Generale: Rogue Traders and the Principal–Agent Problem......Page 457
Measuring Bank Performance......Page 458
Questions......Page 463
Quantitative Problems......Page 464
Web Exercises......Page 465
Asymmetric Information and Financial Regulation......Page 466
GLOBAL: The Spread of Government Deposit Insurance Throughout the World: Is This a Good Thing?......Page 468
GLOBAL: Whither the Basel Accord?......Page 473
MINI-CASE: Mark-to-Market Accounting and the 2007–2009 Financial Crisis......Page 478
MINI-CASE: The 2007–2009 Financial Crisis and Consumer Protection Regulation......Page 479
E-FINANCE: Electronic Banking: New Challenges for Bank Regulation......Page 480
GLOBAL: International Financial Regulation......Page 481
The 1980s Savings and Loan and Banking Crisis......Page 484
Federal Deposit Insurance Corporation Improvement Act of 1991......Page 485
Banking Crises Throughout the World in Recent Years......Page 486
The Dodd-Frank Bill and Future Regulation......Page 489
Questions......Page 492
Quantitative Problems......Page 493
Web Appendices......Page 494
Historical Development of the Banking System......Page 495
Financial Innovation and the Growth of the Shadow Banking System......Page 498
E-FINANCE: Will "Clicks" Dominate "Bricks" in the Banking Industry?......Page 502
E-FINANCE: Why Are Scandinavians So Far Ahead of Americans in Using Electronic Payments and Online Banking?......Page 503
E-FINANCE: Are We Headed for a Cashless Society?......Page 504
THE PRACTICING MANAGER: Profiting from a New Financial Product: A Case Study of Treasury Strips......Page 508
Structure of the U.S. Commercial Banking Industry......Page 514
Bank Consolidation and Nationwide Banking......Page 516
E-FINANCE: Information Technology and Bank Consolidation......Page 518
MINI-CASE: The 2007-2009 Financial Crisis and the Demise of Large, Free-Standing Investment Banks......Page 522
Thrift Industry: Regulation and Structure......Page 523
International Banking......Page 524
Summary......Page 527
Questions......Page 528
Web Exercises......Page 529
The Growth of Mutual Funds......Page 530
Mutual Fund Structure......Page 535
CASE: Calculating a Mutual Fund's Net Asset Value......Page 536
Investment Objective Classes......Page 538
Fee Structure of Investment Funds......Page 542
Regulation of Mutual Funds......Page 543
Hedge Funds......Page 544
MINI-CASE: The Long Term Capital Debacle......Page 546
Conflicts of Interest in the Mutual Fund Industry......Page 547
CONFLICTS OF INTEREST: Many Mutual Funds Are Caught Ignoring Ethical Standards......Page 548
CONFLICTS OF INTEREST: SEC Survey Reports Mutual Fund Abuses Widespread......Page 550
Key Terms......Page 551
Quantitative Problems......Page 552
Web Exercises......Page 553
Preview......Page 554
Insurance Companies......Page 555
Fundamentals of Insurance......Page 556
Growth and Organization of Insurance Companies......Page 558
Types of Insurance......Page 559
THE PRACTICING MANAGER: Insurance Management......Page 567
CONFLICTS OF INTEREST: The AIG Blowup......Page 571
CONFLICTS OF INTEREST: The Subprime Financial Crisis and the Monoline Insurers......Page 572
Types of Pensions......Page 573
MINI-CASE: Power to the Pensions......Page 575
Regulation of Pension Plans......Page 578
Summary......Page 581
Quantitative Problems......Page 582
Web Exercises......Page 583
Preview......Page 584
Investment Banks......Page 585
FOLLOWING THE FINANCIAL NEWS: New Securities Issues......Page 589
Securities Brokers and Dealers......Page 593
Regulation of Securities Firms......Page 597
Private Equity Investment......Page 599
Private Equity Buyouts......Page 603
E-FINANCE: Venture Capitalists Lose Focus with Internet Companies......Page 604
Summary......Page 605
Questions......Page 606
Quantitative Problems......Page 607
Web Exercises......Page 608
Preview......Page 609
Managing Credit Risk......Page 610
Managing Interest-Rate Risk......Page 614
THE PRACTICING MANAGER: Strategies for Managing Interest-Rate Risk......Page 625
Summary......Page 626
Quantitative Problems......Page 627
Web Exercises......Page 630
Hedging......Page 631
THE PRACTICING MANAGER: Hedging Interest-Rate Risk with Forward Contracts......Page 632
Financial Futures Markets......Page 634
FOLLOWING THE FINANCIAL NEWS: Financial Futures......Page 635
THE PRACTICING MANAGER: Hedging with Financial Futures......Page 636
MINI-CASE: The Hunt Brothers and the Silver Crash......Page 641
Hedging Foreign Exchange Risk with Forward Contracts......Page 642
Hedging Foreign Exchange Risk with Futures Contracts......Page 643
MINI-CASE: Program Trading and Portfolio Insurance: Were They to Blame for the Stock Market Crash of 1987?......Page 644
FOLLOWING THE FINANCIAL NEWS: Stock Index Futures......Page 645
THE PRACTICING MANAGER: Hedging with Stock Index Futures......Page 646
Options......Page 647
THE PRACTICING MANAGER: Hedging with Futures Options......Page 652
THE PRACTICING MANAGER: Hedging with Interest-Rate Swaps......Page 654
Credit Derivatives......Page 657
CASE: Lessons from the Subprime Financial Crisis: When Are Financial Derivatives Likely to Be a Worldwide Time Bomb?......Page 659
Summary......Page 660
Quantitative Problems......Page 661
Web Appendices......Page 664
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