Money, Banking and Financial Markets

Title
Contents
Part I Money and the Financial System
	CHAPTER 1 An Introduction to Money and the Financial System
		The Six Parts of the Financial System
		The Five Core Principles of Money and Banking
		Core Principle 1: Time Has Value
		Core Principle 2: Risk Requires Compensation
		Core Principle 3: Information Is the Basis for Decisions
		Core Principle 4: Markets Determine Prices and Allocate Resources
		Core Principle 5: Stability Improves Welfare
		Special Features of This Book
		Your Financial World
		Applying the Concept
		Lessons from the Crisis
		In the News
		Tools of the Trade
		The Organization of This Book
		Learning Tools Your Financial World: Guard Your Identity
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
		Appendix to Chapter 1: Measuring Economic Activity, Prices, and the Infl ation Rate
	CHAPTER 2 Money and the Payments System
		Money and How We Use It
		Means of Payment
		Unit of Account
		Store of Value
		The Payments System
		Commodity and Fiat Monies
		Checks
		Electronic Payments
		The Future of Money
		Measuring Money
		Learning Tools Your Financial World: Debit Cards versus Credit Cards
		Your Financial World: Paper Checks Become Digital Images
		Lessons from the Crisis: Market Liquidity, Funding Liquidity, and Making Markets
		In the News: Dad, Can You Text Me $200?
		Tools of the Trade: The Consumer Price Index
		Applying the Concept: Where Are All Those $100 Bills?
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
	CHAPTER 3 Financial Instruments, Financial Markets, and Financial Institutions
		Financial Instruments
		Uses of Financial Instruments
		Characteristics of Financial Instruments: Standardization and Information
		Underlying versus Derivative Instruments
		A Primer for Valuing Financial Instruments
		Examples of Financial Instruments
		Financial Markets
		The Role of Financial Markets
		The Structure of Financial Markets
		Characteristics of a Well-Run Financial Market
		Financial Institutions
		The Role of Financial Institutions
		The Structure of the Financial Industry
		Learning Tools Lessons from the Crisis: Leverage
		Your Financial World: Disability Income Insurance
		Tools of the Trade: Trading in Financial Markets
		In the News: Lessons of the Financial Crisis—One Year Later
		Lessons from the Crisis: Interbank Lending
		Lessons from the Crisis: Shadow Banks
		Your Financial World: Shop for a Mortgage
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
Part II Interest Rates, Financial Instruments, and Financial Markets
	CHAPTER 4 Future Value, Present Value, and Interest Rates
		Valuing Monetary Payments Now and in the Future
		Future Value and Compound Interest
		Present Value
		Applying Present Value
		Internal Rate of Return
		Bonds: The Basics
		Real and Nominal Interest Rates
		Learning Tools Your Financial World: How Long Does Your Investment Take to Double?
		Lessons from the Crisis: Risk Taking and the Search for Yield
		Tools of the Trade: Computing Compound Annual Rates
		Your Financial World: Should You Buy a New Car Now or Wait?
		Applying the Concept: Early Retirement
		In the News: Economic Scene: Pentagon Shows That It Doesn’t Always Pay to Take the Money and Run
		Your Financial World: Pay Off Your Credit Card Debt as Fast as You Can
		Applying the Concept: High Interest Rates, Low Interest Rates
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
		Appendix to Chapter 4: The Algebra of Present-Value Formulas
	CHAPTER 5 Understanding Risk
		Defi ning Risk
		Measuring Risk
		Possibilities, Probabilities, and Expected Value
		Measures of Risk
		Risk Aversion, the Risk Premium, and the Risk-Return Trade-off
		Sources of Risk: Idiosyncratic and Systematic Risk
		Reducing Risk through Diversifi cation
		Hedging Risk
		Spreading Risk
		Learning Tools Applying the Concept: It’s Not Just Expected Return That Matters
		Your Financial World: Choosing the Right Amount of Car Insurance
		Tools of the Trade: The Impact of Leverage on Risk
		Lessons from the Crisis: Systemic Risk
		Your Financial World: Your Risk Tolerance
		In the News: How to Achieve Effective Portfolio Diversifi cation
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
		Appendix A to Chapter 5: A Quick Test to Measure Investment Risk Tolerance
		Appendix B to Chapter 5: The Mathematics of Diversifi cation
	CHAPTER 6 Bonds, Bond Prices, and the Determination of Interest Rates
		Bond Prices
		Zero-Coupon Bonds
		Fixed-Payment Loans
		Coupon Bonds
		Consols
		Bond Yields
		Yield to Maturity
		Current Yield
		Holding Period Returns
		The Bond Market and the Determination of Interest Rates
		Bond Supply, Bond Demand, and Equilibrium in the Bond Market
		Factors That Shift Bond Supply
		Factors That Shift Bond Demand
		Understanding Changes in Equilibrium Bond Prices and Interest Rates
		Why Bonds Are Risky
		Default Risk
		Infl ation Risk
		Interest-Rate Risk
		Learning Tools Your Financial World: Know Your Mortgage
		Tools of the Trade: Reading the Bond Page
		Your Financial World: Understanding the Ads in the Newspaper
		Applying the Concept: When Russia Defaulted
		Applying the Concept: Securitization
		Your Financial World: Bonds Guaranteed to Beat Infl ation
		In the News: Revival in ‘Private-Label’ Mortgage Securities?
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
	CHAPTER 7 The Risk and Term Structure of Interest Rates
		Ratings and the Risk Structure of Interest Rates
		Bond Ratings
		Commercial Paper Ratings
		The Impact of Ratings on Yields
		Differences in Tax Status and Municipal Bonds
		The Term Structure of Interest Rates
		The Expectations Hypothesis
		The Liquidity Premium Theory
		The Information Content of Interest Rates
		Information in the Risk Structure of Interest Rates
		Information in the Term Structure of Interest Rates
		Learning Tools Lessons from the Crisis: Subprime Mortgages
		Lessons from the Crisis: Rating Agencies
		Your Financial World: Your Credit Rating
		Lessons from the Crisis: Asset-Backed Commercial Paper
		Tools of the Trade: Reading Charts
		Applying the Concept: The Flight to Quality
		In the News: Banks Decline Yield Curve Invitation to Party On
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
	CHAPTER 8 Stocks, Stock Markets, and Market Effi ciency
		The Essential Characteristics of Common Stock
		Measuring the Level of the Stock Market
		The Dow Jones Industrial Average
		The Standard & Poor’s 500 Index
		Other U.S. Stock Market Indexes
		World Stock Indexes
		Valuing Stocks
		Fundamental Value and the Dividend-Discount Model
		Why Stocks Are Risky
		Risk and the Value of Stocks
		The Theory of Effi cient Markets
		Investing in Stocks for the Long Run
		The Stock Market’s Role in the Economy
		Learning Tools Your Financial World: A Home Is a Place to Live
		Tools of the Trade: Reading Stock Indexes in the Business News
		Your Financial World: Beware Percentage Changes
		Applying the Concept: The Chinese Stock Market
		Your Financial World: Should You Own Stocks?
		In the News: Effi cient Market Theory and the Crisis
		Applying the Concept: What Was the Internet Bubble All About?
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
	CHAPTER 9 Derivatives: Futures, Options, and Swaps
		The Basics: Defi ning Derivatives
		Forwards and Futures
		Margin Accounts and Marking to Market
		Hedging and Speculating with Futures
		Arbitrage and the Determinants of Futures Prices
		Options
		Calls, Puts, and All That: Defi nitions
		Using Options
		Pricing Options: Intrinsic Value and the Time Value of the Option
		The Value of Options: Some Examples
		Swaps
		Interest-Rate Swaps
		Credit-Default Swaps
		Learning Tools Lessons from the Crisis: Centralized Counterparties and Systemic Risk
		Your Financial World: Should You Believe Corporate Financial Statements?
		Your Financial World: Should You Accept Options as Part of Your Pay?
		Applying the Concept: What Was Long-Term Capital Management Doing?
		In the News: AIG Still Faces Billions in Credit Losses
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
	CHAPTER 10 Foreign Exchange
		Foreign Exchange Basics
		The Nominal Exchange Rate
		The Real Exchange Rate
		Foreign Exchange Markets
		Exchange Rates in the Long Run
		The Law of One Price
		Purchasing Power Parity
		Exchange Rates in the Short Run
		The Supply of Dollars
		The Demand for Dollars
		Equilibrium in the Market for Dollars
		Shifts in the Supply of and Demand for Dollars
		Explaining Exchange Rate Movements
		Government Policy and Foreign Exchange Intervention
		Learning Tools Tools of the Trade: Following Exchange Rates in the News
		Your Financial World: Investing Overseas
		Applying the Concept: The Big Mac Index
		Your Financial World: Don’t Bet on Exchange Rates
		Lessons from the Crisis: Currency Risk and Rollover Risk
		In the News: U.S. in Standoff with Beijing over Chinese Currency
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
		Appendix to Chapter 10: Interest-Rate Parity and Short-Run Exchange Rate Determination
Part III Financial Institutions
	CHAPTER 11 The Economics of Financial Intermediation
		The Role of Financial Intermediaries
		Pooling Savings
		Safekeeping, Payments System Access, and Accounting
		Providing Liquidity
		Diversifying Risk
		Collecting and Processing Information
		Information Asymmetries and Information Costs
		Adverse Selection
		Solving the Adverse Selection Problem
		Moral Hazard: Problem and Solutions
		Financial Intermediaries and Information Costs
		Screening and Certifying to Reduce Adverse Selection
		Monitoring to Reduce Moral Hazard
		How Companies Finance Growth and Investment
		Learning Tools Your Financial World: Your First Credit Card
		Applying the Concept: The Madoff Scandal
		Your Financial World: Private Mortgage Insurance
		Applying the Concept: Defl ation, Net Worth, and Information Costs
		Lessons from the Crisis: Information Asymmetry and Securitization
		In the News: In a Tight Market, Borrowers Turn to Peers
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
	CHAPTER 12 Depository Institutions: Banks and Bank Management
		The Balance Sheet of Commercial Banks
		Assets: Uses of Funds
		Liabilities: Sources of Funds
		Bank Capital and Profi tability
		Off-Balance-Sheet Activities
		Bank Risk: Where It Comes from and What to Do about It
		Liquidity Risk
		Credit Risk
		Interest-Rate Risk
		Trading Risk
		Other Risks
		Learning Tools Your Financial World: Choosing the Right Bank for You
		Tools of the Trade: A Catalog of Depository Institutions
		Applying the Concept: Growth and Banking in China and India
		Your Financial World: The Cost of Payday Loans
		Lessons from the Crisis: Insuffi cient Bank Capital
		In the News: Rogue Flight: Societe Generale’s Kerviel Tags Leeson
		Applying the Concept: Japanese and U.S. Commercial Banking in the 1990s
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
	CHAPTER 13 Financial Industry Structure
		Banking Industry Structure
		A Short History of U.S. Banking
		Competition and Consolidation
		The Globalization of Banking
		The Future of Banks
		Nondepository Institutions
		Insurance Companies
		Pension Funds
		Securities Firms: Brokers, Mutual Funds, and Investment Banks
		Finance Companies
		Government-Sponsored Enterprises
		Learning Tools Your Financial World: Pawnshops
		Your Financial World: How Much Life Insurance Do You Need?
		Applying the Concept: Reinsurance and “Cat Bonds”
		Applying the Concept: Public Pensions and the Social Security System
		Tools of the Trade: Hedge Funds
		In the News: Fed’s Tarullo Says Dividing Banks May Not Curb Too Big to Fail
		Your Financial World: Annuities
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
	CHAPTER 14 Regulating the Financial System
		The Sources and Consequences of Runs, Panics, and Crises
		The Government Safety Net
		The Unique Role of Banks and Shadow Banks
		The Government as Lender of Last Resort
		Government Deposit Insurance
		Problems Created by the Government Safety Net
		Regulation and Supervision of the Financial System
		Restrictions on Competition
		Asset Holding Restrictions and Minimum Capital Requirements
		Disclosure Requirements
		Supervision and Examination
		Evolving Challenges for Regulators and Supervisors
		Micro-prudential Versus Macro-prudential Regulation
		Learning Tools Your Financial World: The Securities Investor Protection Corporation
		Applying the Concept: The Day the Bank of New York Borrowed $23 Billion
		Lessons from the Crisis: Should the Lender of Last Resort Also Supervise?
		Applying the Concept: Does Deposit Insurance Really Work?
		Your Financial World: Are Your Deposits Insured?
		Tools of the Trade: The Basel Accords, Old and New
		In the News: New Bank Rules Sink Stocks
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
Part IV Central Banks, Monetary Policy, and Financial Stability
	CHAPTER 15 Central Banks in the World Today
		The Basics: How Central Banks Originated and Their Role Today
		The Government’s Bank
		The Bankers’ Bank
		Stability: The Primary Objective of All Central Banks
		Low, Stable Infl ation
		High, Stable Real Growth
		Financial System Stability
		Interest-Rate and Exchange-Rate Stability
		Meeting the Challenge: Creating a Successful Central Bank
		The Need for Independence
		Decision Making by Committee
		The Need for Accountability and Transparency
		The Policy Framework, Policy Trade-offs, and Credibility
		Fitting Everything Together: Central Banks and Fiscal Policy
		Learning Tools Applying the Concept: Why Is Stable Money Such a Big Deal?
		Your Financial World: Why Infl ation Is Bad for You
		Lessons from the Crisis: Threats to Fed Independence
		Applying the Concept: Independent Central Banks Deliver Lower Infl ation
		In the News: Beware the Result of Outrage
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
	CHAPTER 16 The Structure of Central Banks: The Federal Reserve and the European Central Bank
		The Structure of the Federal Reserve System
		The Federal Reserve Banks
		The Board of Governors
		The Federal Open Market Committee
		Assessing the Federal Reserve System’s Structure
		Independence from Political Infl uence
		Decision Making by Committee
		Accountability and Transparency
		Policy Framework
		The European Central Bank
		Organizational Structure
		Accountability and Transparency
		The Price Stability Objective and Monetary Policy Strategy
		Learning Tools Your Financial World: Treasury Direct
		Tools of the Trade: Decoding the FOMC Statement
		Applying the Concept: The Evolution of Federal Reserve Independence
		Your Financial World: The Fed Can’t Save You from a Stock-Market Crash
		In the News: Fed Adopts De Facto Infl ation Target
		Lessons from the Crisis: Government Funding in the Euro Area
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
	CHAPTER 17 The Central Bank Balance Sheet and the Money Supply Process
		The Central Bank’s Balance Sheet
		Assets
		Liabilities
		The Importance of Disclosure
		The Monetary Base
		Changing the Size and Composition of the Balance Sheet
		Open Market Operations
		Foreign Exchange Intervention
		Discount Loans
		Cash Withdrawal
		The Deposit Expansion Multiplier
		Deposit Creation in a Single Bank
		Deposit Expansion in a System of Banks
		The Monetary Base and the Money Supply
		Deposit Expansion with Excess Reserves and Cash Withdrawals
		The Arithmetic of the Money Multiplier
		The Limits of the Central Bank’s Ability to Control the Quantity of Money
		Learning Tools Applying the Concept: The Fed’s Balance Sheet: Impact of the Crisis
		Your Financial World: Why We Still Have Cash
		Applying the Concept: The Fed’s Response on September 11, 2001
		Your Financial World: Your Excess Reserves
		Lessons from the Crisis: The Impact on Money Supply
		Applying the Concept: Monetary Policy in the 1930s
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
	CHAPTER 18 Monetary Policy: Stabilizing the Domestic Economy
		The Federal Reserve’s Conventional Policy Toolbox
		The Target Federal Funds Rate and Open Market Operations
		Discount Lending, the Lender of Last Resort, and Crisis Management
		Reserve Requirements
		Operational Policy at the European Central Bank
		The ECB’s Target Interest Rate and Open Market Operations
		The Marginal Lending Facility
		The Deposit Facility
		Reserve Requirements
		Linking Tools to Objectives: Making Choices
		Desirable Features of a Policy Instrument
		Operating Instruments and Intermediate Targets
		A Guide to Central Bank Interest Rates: The Taylor Rule
		Unconventional Policy Tools
		Policy Duration Commitment
		Quantitative Easing
		Credit Easing
		Making an Effective Exit
		Concluding Remarks
		Learning Tools Your Financial World: What the Federal Funds Rate Means to You
		Applying the Concept: The Channel System and the Future of Monetary Policy
		Tools of the Trade: Some Unconventional Policy Tools
		Applying the Concept: Infl ation Targeting
		In the News: Fed May Take Chance End to Debt Purchases Won’t Hurt Housing
		Your Financial World: Economic History Is Constantly Changing
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
	CHAPTER 19 Exchange-Rate Policy and the Central Bank
		Linking Exchange-Rate Policy with Domestic Monetary Policy
		Infl ation and the Long-Run Implications of Purchasing Power Parity
		Interest Rates and the Short-Run Implications of Capital Market Arbitrage
		Capital Controls and the Policymakers’ Choice
		Mechanics of Exchange-Rate Management
		The Central Bank’s Balance Sheet
		Sterilized Intervention
		The Costs, Benefi ts, and Risks of Fixed Exchange Rates
		Assessing the Costs and Benefi ts
		The Danger of Speculative Attacks
		Summarizing the Case for a Fixed Exchange Rate
		Fixed Exchange-Rate Regimes
		Exchange-Rate Pegs and the Bretton Woods System
		Hard Pegs: Currency Boards and Dollarization
		Learning Tools Your Financial World: Emerging Market Crises and You
		Applying the Concept: Malaysia Imposes Capital Controls
		Applying the Concept: The Gold Standard: An Exchange-Rate Regime Whose Time Has Passed
		Your Financial World: Should You Buy Gold?
		Applying the Concept: Implications of China’s Exchange- Rate Regime
		In the News: As Budget Defi cit Grows, So Do Doubts on Dollar
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
		Appendix to Chapter 19: What You Really Need to Know about the Balance of Payments
Part V Modern Monetary Economics
	CHAPTER 20 Money Growth, Money Demand, and Modern Monetary Policy
		Why We Care about Monetary Aggregates
		The Quantity Theory and the Velocity of Money
		Velocity and the Equation of Exchange
		The Quantity Theory of Money
		The Facts about Velocity
		The Demand for Money
		The Transactions Demand for Money
		The Portfolio Demand for Money
		Targeting Money Growth in a Low-Infl ation Environment
		The Instability of U.S. Money Demand
		Targeting Money Growth: The Fed and the ECB
		Learning Tools Applying the Concept: Infl ation and the Collapse of the Soviet Union
		Your Financial World: Understanding Infl ation Statistics
		Applying the Concept: The ECB’s Reference Value for Money Growth
		Your Financial World: Free Checking Accounts Are Rarely Free
		Tools of the Trade: Using Statistical Models in Policy Evaluation
		Applying the Concept: Financial Innovation and the Shifting Velocity of Money
		In the News: The Issing Link
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
	CHAPTER 21 Output, Infl ation, and Monetary Policy
		Output and Infl ation in the Long Run
		Potential Output
		Long-Run Infl ation
		Monetary Policy and the Dynamic Aggregate Demand Curve
		Aggregate Expenditure and the Real Interest Rate
		Infl ation, the Real Interest Rate, and the Monetary Policy Reaction Curve
		The Dynamic Aggregate Demand Curve
		Aggregate Supply
		Short-Run Aggregate Supply
		Shifts in the Short-Run Aggregate Supply Curve
		The Long-Run Aggregate Supply Curve
		Equilibrium and the Determination of Output and Infl ation
		Short-Run Equilibrium
		Adjustment to Long-Run Equilibrium
		The Sources of Fluctuations in Output and Infl ation
		What Causes Recessions?
		Learning Tools Your Financial World: Using the Word Infl ation
		Applying the Concept: Investment and the Business Cycle
		Your Financial World: It’s the Real Interest Rate that Matters
		Applying the Concept: Infl ation Changes and Output Gaps
		Tools of the Trade: Output Growth and Output Gaps
		In the News: Independence Day for the Fed
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
	CHAPTER 22 Understanding Business Cycle Fluctuations
		Sources of Fluctuations in Output and Infl ation
		Shifts in the Dynamic Aggregate Demand Curve
		Shifts in the Short-Run Aggregate Supply Curve
		Using the Aggregate Demand–Aggregate Supply Framework
		How Do Policymakers Achieve Their Stabilization Objectives?
		What Accounts for the Great Moderation?
		What Happens When Potential Output Changes?
		What Are the Implications of Globalization for Monetary Policy?
		Can Policymakers Distinguish a Recessionary Gap from a Fall in Potential Output?
		Can Policymakers Stabilize Output and Infl ation Simultaneously?
		Learning Tools Tools of the Trade: Defi ning a Recession: The NBER Reference Cycle
		Your Financial World: Stabilizing Your Consumption
		Your Financial World: The Problem with Measuring GDP
		In the News: Infl ation Worry Limits Fed Flexibility
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
	CHAPTER 23 Modern Monetary Policy and the Challenges Facing Central Bankers
		The Monetary Policy Transmission Mechanism
		The Traditional Channels: Interest Rates and Exchange Rates
		Bank-Lending and Balance-Sheet Channels
		Asset-Price Channels: Wealth and Investment
		Financial Crisis Obstructs Monetary Policy Transmission
		The Challenges Modern Monetary Policymakers Face
		Booms and Busts in Property and Equity Prices
		Defl ation and the Zero Nominal-Interest-Rate Bound
		The Evolving Structure of the Financial System
		Learning Tools Tools of the Trade: Correlation Does Not Imply Causality
		Your Financial World: Don’t Count on Infl ation to Bail You Out
		Applying the Concept: What Happened in Japan?
		Your Financial World: Know the Level of Infl ation
		In the News: Bernanke’s How-To on Rate Increase Lacks a When
		Terms
		Chapter Lessons
		Conceptual Problems
		Analytical Problems
Glossary
Photo Credits
Index