Financial Markets and Institutions

Cover......Page 1
Title Page......Page 2
Copyright Page......Page 5
Contents in Brief......Page 8
Contents in Detail......Page 10
Contents on the Web......Page 28
Preface......Page 32
Acknowledgments......Page 38
About the Authors......Page 40
  Preview......Page 42
   Debt Markets and Interest Rates......Page 43
   The Stock Market......Page 44
   The Foreign Exchange Market......Page 45
   Financial Crises......Page 47
   Financial Innovation......Page 48
  Applied Managerial Perspective......Page 49
   Exploring the Web......Page 50
  Web Exercise......Page 51
  Summary......Page 53
  Questions......Page 54
  Web Exercises......Page 55
  Preview......Page 56
  Function of Financial Markets......Page 57
   Primary and Secondary Markets......Page 59
   Exchanges and Over-the-Counter Markets......Page 60
   International Bond Market, Eurobonds, and Eurocurrencies......Page 61
   Global: Are U.S. Capital Markets Losing Their Edge?......Page 62
  Function of Financial Intermediaries: Indirect Finance......Page 63
   Transaction Costs......Page 64
   Risk Sharing......Page 65
   Asymmetric Information: Adverse Selection and Moral Hazard......Page 66
   Economies of Scope and Conflicts of Interest......Page 67
   Depository Institutions......Page 68
   Contractual Savings Institutions......Page 69
   Investment Intermediaries......Page 71
  Regulation of the Financial System......Page 72
   Ensuring the Soundness of Financial Intermediaries......Page 73
   Financial Regulation Abroad......Page 74
  Summary......Page 75
  Questions......Page 76
  Web Exercises......Page 77
  Preview......Page 78
   Present Value......Page 79
   Four Types of Credit Market Instruments......Page 81
   Yield to Maturity......Page 82
   Global: Negative Interest Rates? Japan First, Then the United States, Then Europe......Page 88
  The Distinction Between Real and Nominal Interest Rates......Page 89
  The Distinction Between Interest Rates and Returns......Page 92
   Maturity and the Volatility of Bond Returns: Interest-Rate Risk......Page 95
   Reinvestment Risk......Page 96
   The Practicing Manager: Calculating Duration to Measure Interest-Rate Risk......Page 97
   Calculating Duration......Page 98
   Duration and Interest-Rate Risk......Page 102
  Summary......Page 103
  Quantitative Problems......Page 104
  Web Exercises......Page 106
  Preview......Page 107
   Expected Returns......Page 108
   Risk......Page 109
  Supply and Demand in the Bond Market......Page 111
   Demand Curve......Page 112
   Supply Curve......Page 113
   Market Equilibrium......Page 114
  Changes in Equilibrium Interest Rates......Page 115
   Shifts in the Demand for Bonds......Page 116
   Shifts in the Supply of Bonds......Page 119
   Case: Changes in the Interest Rate Due to Expected Inflation: The Fisher Effect......Page 121
   Case: Changes in the Interest Rate Due to a Business Cycle Expansion......Page 123
   Case: Explaining the Current Low Interest Rates in Europe, Japan, and the United States......Page 124
   The Practicing Manager: Profiting from Interest-Rate Forecasts......Page 125
  Questions......Page 127
  Quantitative Problems......Page 128
  Web Appendices......Page 129
  Preview......Page 130
   Default Risk......Page 131
   Case: The Global Financial Crisis and the Baa-Treasury Spread......Page 134
   Income Tax Considerations......Page 135
   Summary......Page 136
   Case: Effects of the Bush Tax Cut and the Obama Tax Increase on Bond Interest Rates......Page 137
  Term Structure of Interest Rates......Page 138
   Following the Financial News: Yield Curves......Page 139
   Expectations Theory......Page 140
   Market Segmentation Theory......Page 144
   Liquidity Premium Theory......Page 145
   Evidence on the Term Structure......Page 148
   Summary......Page 149
   Case: Interpreting Yield Curves, 1980–2016......Page 150
   The Practicing Manager: Using the Term Structure to Forecast Interest Rates......Page 151
  Summary......Page 154
  Questions......Page 155
  Quantitative Problems......Page 156
  Web Exercises......Page 157
  Preview......Page 158
  The Efficient Market Hypothesis......Page 159
   Rationale Behind the Hypothesis......Page 161
   Evidence in Favor of Market Efficiency......Page 162
   Mini-Case: An Exception That Proves the Rule: Raj Rajaratnam and Galleon......Page 163
   Case: Should Foreign Exchange Rates Follow a Random Walk?......Page 165
   Evidence Against Market Efficiency......Page 166
   How Valuable Are Published Reports by Investment Advisers?......Page 168
   Should You Be Skeptical of Hot Tips?......Page 169
   Efficient Markets Prescription for the Investor......Page 170
  Why the Efficient Market Hypothesis Does Not Imply That Financial Markets Are Efficient......Page 171
  Behavioral Finance......Page 172
  Summary......Page 173
  Questions......Page 174
  Web Exercises......Page 175
  Preview......Page 176
  Basic Facts About Financial Structure Throughout the World......Page 177
   How Financial Intermediaries Reduce Transaction Costs......Page 180
  Asymmetric Information: Adverse Selection and Moral Hazard......Page 181
  The Lemons Problem: How Adverse Selection Influences Financial Structure......Page 182
   Tools to Help Solve Adverse Selection Problems......Page 183
   Mini-Case: The Enron Implosion......Page 185
   Moral Hazard in Equity Contracts: The Principal–Agent Problem......Page 188
   Tools to Help Solve the Principal–Agent Problem......Page 189
   Tools to Help Solve Moral Hazard in Debt Contracts......Page 191
   Summary......Page 193
   Case: Financial Development and Economic Growth......Page 195
   Mini-Case: The Tyranny of Collateral......Page 196
   Case: Is China a Counter-Example to the Importance of Financial Development?......Page 197
   Why Do Conflicts of Interest Arise?......Page 198
   Mini-Case: The Demise of Arthur Andersen......Page 200
   What Has Been Done to Remedy Conflicts of Interest?......Page 201
  Summary......Page 203
  Questions......Page 204
  Quantitative Problems......Page 205
  Web Exercises......Page 206
  Preview......Page 207
   Stage One: Initial Phase......Page 208
   Stage Two: Banking Crisis......Page 211
   Bank Panics......Page 212
   Continuing Decline in Stock Prices......Page 213
   International Dimensions......Page 214
   Causes of the 2007–2009 Financial Crisis......Page 215
   Mini-Case: Collateralized Debt Obligations (CDOs)......Page 216
   Effects of the 2007–2009 Financial Crisis......Page 217
   Inside the Fed: Was the Fed to Blame for the Housing Price Bubble?......Page 218
   Global: The European Sovereign Debt Crisis......Page 221
   Height of the 2007–2009 Financial Crisis......Page 222
  Summary......Page 223
  Web Exercises......Page 224
  Web References......Page 225
  Preview......Page 226
   Global: Who Should Own Central Banks?......Page 227
  Variations in the Functions and Structures of Central Banks......Page 228
   The European Central Bank, the Euro System, and the European System of Central Banks......Page 229
   Decision-Making Bodies of the ECB......Page 231
   How Monetary Policy is Conducted within the ECB......Page 232
   Global: The Importance of the Bundesbank within the ECB......Page 233
   Global: Are Non-Euro Central Banks Constrained by Membership of the EU?......Page 234
   Difference between the ECB and the Fed......Page 235
   The Bank of England......Page 236
  Structure of Central Banks of Larger Economies......Page 237
   The Bank of Canada......Page 238
   The People’s Bank of China......Page 239
  Structure and Independence of Central Banks of Emerging Market Economies......Page 240
   The Case Against Independence......Page 241
  Summary......Page 242
  Questions and Problems......Page 243
  Web Exercises......Page 244
  Preview......Page 245
   Open Market Operations......Page 246
   Discount Lending......Page 247
   Demand and Supply in the Market for Reserves......Page 248
   How Changes in the Tools of Monetary Policy Affect the Federal Funds Rate......Page 250
   Case: How the Federal Reserve’s Operating Procedures Limit Fluctuations in the Federal Funds Rate......Page 254
   Open Market Operations......Page 255
   Discount Policy and the Lender of Last Resort......Page 256
  Nonconventional Monetary Policy Tools and Quantitative Easing......Page 259
   Liquidity Provision......Page 260
   Inside the Fed: Fed Lending Facilities During the Global Financial Crisis......Page 261
   Quantitative Easing Versus Credit Easing......Page 262
   Forward Guidance......Page 264
   Negative Interest Rates on Banks’ Deposits......Page 265
   Lending to Banks......Page 266
  The Price Stability Goal and the Nominal Anchor......Page 267
   The Time-Inconsistency Problem......Page 268
   High Employment and Output Stability......Page 269
   Interest-Rate Stability......Page 270
   Hierarchical vs. Dual Mandates......Page 271
   Price Stability as the Primary, Long-Run Goal of Monetary Policy......Page 272
   Advantages of Inflation Targeting......Page 273
   Inside the Fed: Ben Bernanke and the Federal Reserve’s Adoption of Inflation Targeting......Page 274
   Disadvantages of Inflation Targeting......Page 275
  Should Central Banks Respond to Asset-Price Bubbles? Lessons from the Global Financial Crisis......Page 276
   Two Types of Asset-Price Bubbles......Page 277
   The Debate over Whether Central Banks Should Try to Pop Bubbles......Page 278
   The Practicing Manager: Using a Fed Watcher......Page 280
  Summary......Page 281
  Key Terms......Page 282
  Questions......Page 283
  Web Exercises......Page 284
  Preview......Page 286
   Why Do We Need the Money Markets?......Page 287
   Money Market Cost Advantages......Page 288
  The Purpose of the Money Markets......Page 289
   Federal Reserve System......Page 290
   Businesses......Page 291
   Individuals......Page 292
   Case: Discounting the Price of Treasury Securities to Pay the Interest......Page 293
   Mini-Case: Treasury Bill Auctions Go Haywire......Page 296
   Federal Funds......Page 297
   Repurchase Agreements......Page 298
   Negotiable Certificates of Deposit......Page 299
   Commercial Paper......Page 300
   Banker’s Acceptances......Page 302
   Global: Ironic Birth of the Eurodollar Market......Page 303
   Interest Rates......Page 304
   Liquidity......Page 305
   How Money Market Securities Are Valued......Page 306
  Questions......Page 307
  Web Exercises......Page 308
  Preview......Page 309
  Capital Market Participants......Page 310
  Treasury Notes and Bonds......Page 311
   Treasury Bond Interest Rates......Page 312
   Agency Bonds......Page 314
   Case: The 2007–2009 Financial Crisis and the Bailout of Fannie Mae and Freddie Mac......Page 315
  Municipal Bonds......Page 316
  Corporate Bonds......Page 318
   Characteristics of Corporate Bonds......Page 319
   Types of Corporate Bonds......Page 321
  Financial Guarantees for Bonds......Page 324
  Current Yield Calculation......Page 325
   Current Yield......Page 326
  Finding the Value of Coupon Bonds......Page 327
   Finding the Price of Semiannual Bonds......Page 328
  Investing in Bonds......Page 330
  Summary......Page 331
  Quantitative Problems......Page 332
  Web Exercise......Page 333
  Preview......Page 334
   Common Stock vs. Preferred Stock......Page 335
   How Stocks Are Sold......Page 336
   The One-Period Valuation Model......Page 340
   The Generalized Dividend Valuation Model......Page 341
   The Gordon Growth Model......Page 342
   Price Earnings Valuation Method......Page 343
  How the Market Sets Security Prices......Page 344
   Problems with Estimating Growth......Page 345
   Problems with Forecasting Dividends......Page 346
   Case: The September 11 Terrorist Attack, the Enron Scandal, and the Stock Market......Page 347
   Mini-Case: History of the Dow Jones Industrial Average......Page 348
   The Securities and Exchange Commission......Page 351
  Summary......Page 352
  Quantitative Problems......Page 353
  Web Exercises......Page 354
  Preview......Page 355
  What Are Mortgages?......Page 356
   Mortgage Interest Rates......Page 357
   Case: The Discount Point Decision......Page 358
   Loan Terms......Page 360
   Mortgage Loan Amortization......Page 361
   Insured and Conventional Mortgages......Page 362
   Other Types of Mortgages......Page 363
  Mortgage-Lending Institutions......Page 365
  Loan Servicing......Page 366
  Secondary Mortgage Market......Page 367
   What Is a Mortgage-Backed Security?......Page 368
   Types of Pass-Through Securities......Page 370
   Subprime Mortgages and CDOs......Page 371
   The Real Estate Bubble......Page 372
  Questions......Page 373
  Quantitative Problems......Page 374
  Web Exercises......Page 375
  Preview......Page 376
  Foreign Exchange Market......Page 377
   Following the Financial News: Foreign Exchange Rates......Page 378
  Exchange Rates in the Long Run......Page 379
   Theory of Purchasing Power Parity......Page 380
   Factors That Affect Exchange Rates in the Long Run......Page 382
   Supply Curve for Domestic Assets......Page 384
   Demand Curve for Domestic Assets......Page 385
   Shifts in the Demand for Domestic Assets......Page 386
   Recap: Factors That Change the Exchange Rate......Page 389
   Case: Effect of Changes in Interest Rates on the Equilibrium Exchange Rate......Page 391
   Case: The Dollar and Interest Rates......Page 393
   Case: The Global Financial Crisis and the Dollar......Page 395
   The Practicing Manager: Profiting from Foreign Exchange Forecasts......Page 396
  Questions......Page 397
  Quantitative Problems......Page 398
  Web Exercises......Page 399
   Comparing Expected Returns on Domestic and Foreign Assets......Page 400
   Interest Parity Condition......Page 402
  Preview......Page 404
   Foreign Exchange Intervention and Reserves in the Banking System......Page 405
   Inside the Fed: A Day at the Federal Reserve Bank of New York’s Foreign Exchange Desk......Page 406
   Sterilized Intervention......Page 407
  Balance of Payments......Page 409
   Fixed Exchange Rate Regimes......Page 410
   How a Fixed Exchange Rate Regime Works......Page 411
   The Policy Trilemma......Page 413
   Monetary Unions......Page 414
   Speculative Attacks......Page 415
   Managed Float......Page 416
   Case: The Foreign Exchange Crisis of September 1992......Page 417
   The Practicing Manager: Profiting from a Foreign Exchange Crisis......Page 419
   Case: How Did China Accumulate over $3 Trillion of International Reserves?......Page 420
   Controls on Capital Inflows......Page 421
   Should the IMF Be an International Lender of Last Resort?......Page 422
  Key Terms......Page 423
  Questions......Page 424
  Web Exercise......Page 425
  Preview......Page 426
   Liabilities......Page 427
   Assets......Page 429
  Basic Banking......Page 430
   Liquidity Management and the Role of Reserves......Page 433
   Asset Management......Page 436
   Liability Management......Page 437
   Capital Adequacy Management......Page 438
   The Practicing Manager: Strategies for Managing Bank Capital......Page 440
  Off-Balance-Sheet Activities......Page 441
   Trading Activities and Risk Management Techniques......Page 442
   Conflicts of Interest: Barings, Daiwa, Sumitomo, Société Générale, and J.P. Morgan Chase: Rogue Traders and the Principal–Agent Problem......Page 443
  Measuring Bank Performance......Page 444
   Bank’s Income Statement......Page 445
   Recent Trends in Bank Performance Measures......Page 447
  Summary......Page 449
  Quantitative Problems......Page 450
  Web Exercises......Page 451
  Preview......Page 452
   Government Safety Net......Page 453
   Global: The Spread of Government Deposit Insurance Throughout the World: Is This a Good Thing?......Page 455
   Restrictions on Asset Holdings......Page 458
   Capital Requirements......Page 459
   Financial Supervision: Chartering and Examination......Page 460
   Global: Where Is the Basel Accord Heading After the Global Financial Crisis?......Page 461
   Assessment of Risk Management......Page 462
   Disclosure Requirements......Page 463
   Consumer Protection......Page 464
   Restrictions on Competition......Page 465
   Mini-Case: The Global Financial Crisis and Consumer Protection Regulation......Page 466
   E-Finance: Electronic Banking: New Challenges for Bank Regulation......Page 467
   Summary......Page 468
   Global: International Financial Regulation......Page 469
   “Déjà Vu All Over Again”......Page 472
   Dodd-Frank......Page 474
   What Can Be Done About the Too-Big-to-Fail Problem?......Page 475
   Other Issues for Future Regulation......Page 476
  Summary......Page 477
  Quantitative Problems......Page 478
  Web Appendix......Page 479
  Preview......Page 480
  Historical Development of the Banking System......Page 481
  Financial Innovation and the Growth of the Shadow Banking System......Page 483
   Responses to Changes in Demand Conditions: Interest Rate Volatility......Page 484
   Responses to Changes in Supply Conditions: Information Technology......Page 485
   E-Finance: Will “Clicks” Dominate “Bricks” in the Banking Industry?......Page 487
   E-Finance: Why Are Scandinavians So Far Ahead of Americans in Using Electronic Payments and Online Banking?......Page 488
   E-Finance: Are We Headed for a Cashless Society?......Page 489
   Securitization and the Shadow Banking System......Page 490
   Avoidance of Existing Regulations......Page 492
   The Practicing Manager: Profiting from a New Financial Product: A Case: Study of Treasury Strips......Page 494
   Financial Innovation and the Decline of Traditional Banking......Page 496
  Structure of the U.S. Banking Industry......Page 499
   Restrictions on Branching......Page 500
   Response to Branching Restrictions......Page 501
  Bank Consolidation and Nationwide Banking......Page 502
   The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994......Page 504
   Are Bank Consolidation and Nationwide Banking Good Things?......Page 505
   Erosion of Glass-Steagall......Page 506
   Implications for Financial Consolidation......Page 507
   Separation of Banking and Other Financial Services Industries Throughout the World......Page 508
   Mutual Savings Banks......Page 509
  International Banking......Page 510
   Structure of U.S. Banking Overseas......Page 511
   Foreign Banks in the United States......Page 512
  Summary......Page 513
  Questions......Page 514
  Web Exercises......Page 515
  Preview......Page 516
  Benefits of Mutual Funds......Page 517
   Ownership of Mutual Funds......Page 518
   Open- Versus Closed-End Funds......Page 521
   Case: Calculating a Mutual Fund’s Net Asset Value......Page 522
   Equity Funds......Page 523
   Bond Funds......Page 525
   Money Market Funds......Page 526
   Index Funds......Page 528
  Fee Structure of Investment Funds......Page 529
  Regulation of Mutual Funds......Page 530
  Hedge Funds......Page 531
   Mini-Case: The Long Term Capital Debacle......Page 533
   Mutual Fund Abuses......Page 534
   Conflicts of Interest: Many Mutual Funds Are Caught Ignoring Ethical Standards......Page 535
   Conflicts of Interest: SEC Survey Reports Mutual Fund Abuses Widespread......Page 536
   Government Response to Abuses......Page 537
  Questions......Page 538
  Quantitative Problems......Page 539
  Web Exercises......Page 540
  Preview......Page 541
  Fundamentals of Insurance......Page 542
   Adverse Selection and Moral Hazard in Insurance......Page 543
   Mini-Case: Insurance Agent: The Customer’s Ally......Page 544
  Types of Insurance......Page 545
   Life Insurance......Page 546
   Health Insurance......Page 550
   Property and Casualty Insurance......Page 552
   Insurance Regulation......Page 553
   Screening......Page 554
   Prevention of Fraud......Page 555
   Limits on the Amount of Insurance......Page 556
   Credit Default Swaps......Page 557
  Pensions......Page 558
   Defined-Benefit Pension Plans......Page 559
   Defined-Contribution Pension Plans......Page 560
   Mini-Case: Power to the Pensions......Page 561
   Employee Retirement Income Security Act......Page 565
  The Future of Pension Funds......Page 567
  Questions......Page 568
  Quantitative Problems......Page 569
  Web Exercises......Page 570
  Preview......Page 571
   Background......Page 572
   Underwriting Stocks and Bonds......Page 573
   Equity Sales......Page 577
   Mergers and Acquisitions......Page 578
  Securities Brokers and Dealers......Page 579
   Brokerage Services......Page 580
   Securities Dealers......Page 582
  Regulation of Securities Firms......Page 583
   Venture Capital Firms......Page 585
   Advantages to Private Equity Buyouts......Page 590
  Summary......Page 591
  Questions......Page 592
  Quantitative Problems......Page 593
  Web Exercises......Page 594
  Preview......Page 595
   Screening and Monitoring......Page 596
   Long-Term Customer Relationships......Page 597
   Collateral......Page 598
   Credit Rationing......Page 599
  Managing Interest-Rate Risk......Page 600
   Income Gap Analysis......Page 601
   Duration Gap Analysis......Page 603
   Example of a Nonbanking Financial Institution......Page 608
   Some Problems with Income Gap and Duration Gap Analyses......Page 610
   The Practicing Manager: Strategies for Managing Interest-Rate Risk......Page 611
  Questions......Page 612
  Quantitative Problems......Page 613
  Web Exercises......Page 615
  Preview......Page 616
   Interest-Rate Forward Contracts......Page 617
   Pros and Cons of Forward Contracts......Page 618
   Financial Futures Contracts......Page 619
   Following the Financial News: Financial Futures......Page 620
   The Practicing Manager: Hedging with Financial Futures......Page 621
   Globalization of Financial Futures Markets......Page 623
   Explaining the Success of Futures Markets......Page 624
   Mini-Case: The Hunt Brothers and the Silver Crash......Page 626
  Hedging Foreign Exchange Risk with Forward Contracts......Page 627
  Stock Index Futures......Page 628
   Following the Financial News: Stock Index Futures......Page 629
   The Practicing Manager: Hedging with Stock Index Futures......Page 630
   Option Contracts......Page 631
   Profits and Losses on Option and Futures Contracts......Page 632
   Factors Affecting the Prices of Option Premiums......Page 635
   The Practicing Manager: Hedging with Futures Options......Page 636
   Interest-Rate Swap Contracts......Page 638
   The Practicing Manager: Hedging with Interest-Rate Swaps......Page 639
   Disadvantages of Interest-Rate Swaps......Page 640
  Credit Derivatives......Page 641
   Credit Swaps......Page 642
   Case: Lessons from the Global Financial Crisis: When Are Financial Derivatives Likely to Be a Worldwide Time Bomb?......Page 643
  Key Terms......Page 645
  Quantitative Problems......Page 646
  Web Appendices......Page 648
Glossary......Page 650
Index......Page 668
Back Cover......Page 706