money and capital markets - gbv · money and capital markets financial institutions and instruments...
Post on 15-Mar-2020
5 Views
Preview:
TRANSCRIPT
Money andCapital Markets
Financial Institutions and Instrumentsin a Global Marketplace
C 254264
Contents
PART1
The Global Financial Systemin Perspective 1
1 Functions and Roles of the FinancialSystem in the Economy 2
1.1 Introduction to the FinancialSystem 3
1.2 The Global Economy and theFinancial System 3Flows within the Global EconomicSystem 3The Role of Markets in the GlobalEconomic System 4Types of Markets 5The Financial Markets and theFinancial System: Channel forSavings and Investment 5Nature of Savings 6Nature of Investment 6
1.3 Economic Functions Performed bythe Global Financial System andthe Financial Markets 7Savings Function 7Wealth Function 8Liquidity Function 9Credit Function 9Payments Function 9Risk Protection Function 10Policy Function 11
1.4 Types of Financial Markets withinthe Global Financial System 11The Money Market versus the CapitalMarket 12Divisions of the Money and CapitalMarkets 12Open versus Negotiated Markets 14
16
23
Primary versus SecondaryMarkets 14Spot versus Futures, Forward, andOption Markets 14
1.5 Factors Tying All FinancialMarkets Together 15Credit, the Common CommoditySpeculation and Arbitrage 16
1.6 The Dynamic FinancialSystem 16
1.7 The Plan of This Book 17Summary of the Chapter's MainPoints 19Key Terms Appearing in ThisChapter 20Problems and Issues 20Web-Based Problems 22Selected References to Explore
Financial Assets, Money, FinancialTransactions, and FinancialInstitutions 25
2.1 Introduction: The Role of FinancialAssets 26
2.2 The Nature and Characteristics ofFinancial Assets 26Characteristics of FinancialAssets 26Types of Financial Assets 27
2.3 How Financial Assets AreCreated 27
2.4 Financial Assets and the FinancialSystem 31
2.5 Lending and Borrowing in theFinancial System 33
2.6 Money as a Financial Asset 36What Is Money? 36The Functions of Money 37The Value of Money and OtherFinancial Assets and Inflation 38
xxii
Contents
2.7 The Evolution of FinancialTransactions 40Direct Finance 40Semidirect Finance 41Indirect Finance and FinancialIntermediation 42
2.8 Relative Sizes and Types of MajorFinancial Institutions 44Comparative Sizes of Key Financial-Service Providers 44Classifying Financial Institutions 45Portfolio (Financial-Asset) Decisionsby Financial Institutions 46
2.9 The Disintermediation of Funds 47New Types of Disintermediation 47
2.10 Bank-Dominated versus Market-Dominated Financial Systems 48Summary of the Chapter's MainPoints 49Key Terms Appearing in ThisChapter 50Problems and Issues 51Web-Based Problems 53Selected References to Explore 53
I The Financial InformationMarketplace 55
3.1 Introduction: The Importanceof Information in the FinancialMarketplace 56
3.2 The Great Debate over EfficientMarkets and AsymmetricInformation 56The Efficient Markets Hypothesis(EMH) 57What Is an Efficient Market? 57Different Forms of the EMH 58Insiders and Insider Trading 59What Is Insider Trading ? 59When Is Insider Trading Legal orIllegal? 59The Asymmetric InformationHypothesis (AIH) 60Problems Asymmetries Can Create:Lemons and Plums 61Problems Asymmetries Can Create:Adverse Selection 62
Problems Asymmetries Can Create:Moral Hazard 63Asymmetry, Efficiency, and Real-World Markets 64Informational Asymmetries and theLaw 65
3.3 Debt Security Prices and Yields:Sources of Information 68Bonds and Notes 68Bid and Asked Prices and PricingInformation 68
3.4 Stock Prices and Dividend Yields:Sources of Information 69Price and Yield Information 70Stock Price Indexes and Foreign StockPrices 70
3.5 Information on SecurityIssuers 71Moody's and Standard & Poor'sReports 71
Securities and Exchange Commission(SEC) Reports 72Company Histories 72Dun & Bradstreet Ratings and Risk
^ Management 72
Financial Institutions 73
Credit Bureaus 733.6 General Economic and Financial
Conditions 73The Federal Reserve System 73Other Domestic and InternationalSources of Information 74Summary of the Chapter's MainPoints 75Key Terms Appearing in ThisChapter 76Problems and Issues 76Web-Based Problems 78Selected References to Explore 79Appendix 3 A: The Flow of Funds inthe Financial System 80
The Future of the Financial Systemand Trends in the Money and CapitalMarkets 884.1 Introduction: The Financial
Markets in Change 89
Contents
4.2 Financial Forces Reshaping the Moneyand Capital Markets Today 89
4.3 Economic and DemographicForces Reshaping the FinancialSystem 91
4.4 The Challenges and OpportunitiesPresented by Recent Trends 94Dealing with Risk in the FinancialSystem: Ensuring the Strength ofFinancial Institutions and IncreasingPublic Confidence 95
The Consequences of Reduced PublicConfidence 95
Ways to Promote Public Confidencein Financial Institutions and ReduceRisk in the Financial System 95
Developing Better Management Toolsto Deal with Risk 97
The Information Problem 98
The Effect of New Technology onthe Design and Delivery of FinancialServices 99The Information Revolution 99Recent Technological Advances 99Public Attitudes and Cost 100The Changing Mix of Financial-ServiceSuppliers in the Financial System 101Price Sensitivity and LocalCompetition 101Importance of Established DeliverySystems 101New Financial Institutions andInstruments 101Securitization 102Consolidations and Convergenceswithin the Financial System 102
4.5 A New Role for Regulationin an Age of Financial-Services: Consolidation andConvergence 104
4.6 The Payments System: Current andFuture 107
4.7 The Current and Future Needfor Regulation of FinancialInstitutions 108Financial Service Regulations ThatCould Grow 109
Financial Disclosure 109
Privacy Protection and IdentityTheft 110
Social Responsibility 111
Promoting a Level Playing Field 111
Summary of the Chapter's MainPoints 112Key Terms Appearing in ThisChapter 113Problems and Issues 113Web-Based Problems 114Selected References to Explore 115
PART 2
Interest Rates and the Prices ofFinancial Assets 117
5 The Determinants of Interest Rates:Competing Ideas 1185.1 Introduction: Interest Rates and the
Price of Credit 1195.2 Functions of the Rate of Interest in
the Economy 1195.3 The Classical Theory of Interest
Rates 120Saving by Households 120Saving by Business Firms 121Saving by Government 122The Demand for InvestmentFunds 122The Investment Decision-MakingProcess 122Investment Demand and the Rate ofInterest 124The Equilibrium Rate of Interest inthe Classical Theory of Interest 124Limitations of the Classical Theory ofInterest 125
5.4 The Liquidity Preference or CashBalances Theory of Interest Rates 126The Demand for Liquidity 126Motives for Holding Money (CashBalances) 127Total Demand for Money (CashBalances) 128
Contents
The Supply of Money (CashBalances) 130The Equilibrium Rate of Interest inLiquidity Preference Theory 130Limitations of the LiquidityPreference Theory 131
5.5 The Loanable Funds Theory ofInterest 132The Demand for Loanable Funds 132Consumer (Household) Demand forLoanable Funds 132Domestic Business Demand forLoanable Funds 132Government Demand for LoanableFunds 132Foreign Demand for LoanableFunds 132Total Demand for LoanableFunds 133The Supply of Loanable Funds 133Domestic Saving 133Dishoarding of Money Balances 134Creation of Credit by the DomesticBanking System 134Foreign Lending to the Domestic FundsMarket 134Total Supply of Loanable Funds 135The Equilibrium Rate of Interest inthe Loanable Funds Theory 135
5.6 The Rational Expectations Theoryof Interest 137Summary of the Chapter's MainPoints 141Key Terms Appearing in ThisChapter 142Problems and Issues 142Web-Based Problems 144Selected References to Explore 145
Measuring and Calculating InterestRates and Financial Asset Prices 1476.1 Introduction to Interest Rates and
Asset Prices 1486.2 Units of Measurement for Interest
Rates 148Calculating and Quoting InterestRates 148Basis Points 148
6.3 Interest Rates in the WholesaleMoney Markets 149Computing Interest Rates on MoneyMarket Assets That Are Sold at aDiscount 149Holding-Period Yield on MoneyMarket Assets Sold at a Discount 150Interest Rate Quotations on U.S.Treasury Bills 151
6.4 Interest Rates on Bonds and OtherLong-Term Debt Securities 152Yield to Maturity (YTM) 152Holding-Period Yield on Bonds andOther Long-Term Debt Securities 153Understanding the Concepts of Yieldto Maturity and Holding-PeriodYield 154
Price Quotations on U.S. TreasuryNotes and Bonds 155Price Quotations on CorporateBonds 156
6.5 Interest Rates and the Prices ofDebt Securities 157
6.6 Rates of Return on a PerpetualFinancial Instrument 160The Rate of Return on Fixed-IncomePerpetuities 160Interest Rates and Stock Prices 161Calculating the Holding-Period Yieldon Stock 162Price Quotations in CorporateStock 162
6.7 Interest Rates Charged byInstitutional Lenders 164The Simple Interest Method 164Add-On Rate of Interest 165Discount Loan Method 165Home Mortgage Interest Rate 165Annual Percentage Rate (APR) 167Compound Interest 168The Annual Percentage Yield (APY)on Deposits 169Summary of the Chapter's MainPoints 170Key Terms Appearing in ThisChapter 171Problems and Issues 172
Contents
Web-Related Problems 173Selected References to Explore 174
Inflation, Yield Curves, and Duration:Impact on Interest Rates and AssetPrices 175
7.1 Introduction 1767.2 Inflation and Interest Rates 176
The Correlation between Inflation andInterest Rates 176
Nominal and Real Interest Rates 177
The Fisher Effect 178Alternative Views about Inflation andInterest Rates 178The Harrod-Keynes Effect of Inflation 178
Anticipated versus UnanticipatedInflation 179The Inflation-Risk Premium 180The Inflation-Caused Income TaxEffect 180
Conclusions from Recent Research onInflation and Interest Rates 181
7.3 Inflation and Stock Prices 1827.4 The Development of Inflation-
Adjusted Securities 1847.5 The Maturity of a Loan 188
The Yield Curve and the TermStructure of Interest Rates 188Types of Yield Curves 189The Unbiased ExpectationsHypothesis 189Assumptions of the ExpectationsHypothesis 191
Policy Implications of the UnbiasedExpectations Hypothesis 191The Liquidity Premium View of theYield Curve 192
7.6 The Segmented-Markets andPreferred Habitat Arguments 193The Possible Impact of SegmentedMarkets on the Yield Curve 193Policy Implications of the Segmented-Markets Theory 194The Preferred Habitat or CompositeTheory of the Yield Curve 194Research Evidence on the YieldCurve 194
8
7.7 Uses of the Yield Curve 197Forecasting Interest Rates 197
Uses for Financial Intermediaries 197
Detecting Overpriced and UnderpricedFinancial Assets 198
Indicating Trade-Offs between Maturityand Yield 198
Riding the Yield Curve 1987.8 Duration: A Different Approach to
Maturity 199The Price Elasticity of a Bond orOther Debt Security 199The Impact of Varying CouponRates 200
An Alternative Maturity Index for aFinancial Asset: Duration 201The Convexity Factor 203Uses of Duration 204Estimating Asset Price Changes 204Portfolio Immunization 205Limitations of Duration 207Summary of the Chapter's MainPoints 208
Key Terms Appearing in ThisChapter 210Problems and Issues 210Web-B ased Problems 213
^Selected References to Explore 214
The Risk Structure of Interest Rates:Defaults, Prepayments, Taxes, andOther Rate-Determining Factors 2168.1 Introduction 2178.2 Marketability 2178.3 Liquidity 2188.4 Default Risk and Interest Rates 218
The Premium for Default Risk 219The Expected Rate of Return or Yieldon a Risky Asset 219Anticipated Loss and Default-RiskPremiums 220
Factors Influencing Default-RiskPremiums 221Inflation and Default-RiskPremiums 223Yield Curves for RiskySecurities 224
Contents xxvii
The Volatile History of Junk Bonds 224The Junk-Bond Spread and theEconomy 226
8.5 New Ways of Dealing with DefaultRisk: Credit Derivatives 227A Summary of the Default Risk—Interest Rate Relationship 229
8.6 Call Privileges and Call Risk 229Calculating the Yields on CalledFinancial Assets 229Advantages and Disadvantages of theCall Privilege 231The Call Premium and Interest RateExpectations 231Research Evidence on Call Privilegesand Call Risk 231
8.7 Prepayment Risk and the Yields onLoan-Backed Securities 232
8.8 Taxation of Returns on FinancialAssets 235Tax-Exempt Securities 235The Effect of Marginal Tax Rates onAfter-Tax Yields 236
Comparing Taxable and Tax-ExemptSecurities 237Treatment of Capital Losses andCapital Gains 238
8.9 Convertible Securities 238Advantages for the Convertible BondIssuer 239
Advantages for the Investor inConvertible Bonds 240
8.10 The Structure of Interest Rates inthe Financial System 240Summary of the Chapter's MainPoints 242Key Terms Appearing in ThisChapter 243Problems and Issues 243Web-Based Problems 245Selected References to Explore 246
Interest Rate Forecasting and Hedging:Swaps, Financial Futures, andOptions 2489.1 Introduction 2499.2 Implicit Interest Rate Forecasts and
Asset Prices 249
9.3 Interest Rate Swaps 250What Are Swaps? 250How Swaps Work 251The Risks of Swapping 253
9.4 Financial Futures Contracts 255The Nature of Futures Trading 255Examples of Daily Price Quotationsfor U.S. Treasury Futures 255Why Hedging with Futures Can BeEffective 256Types of Hedges in Futures 258The Long (or Buying) Hedge 258The Short (or Selling) Hedge 259Cross Hedging 260Executing a Trade, the Cash Margin,and the Settlement of the Contract 261Payoff Diagrams for Long and ShortFutures Contracts 262Futures Contracts Offered onExchanges Today 262
9.5 Option Contracts 264Basic Types of Option Contracts andPrice Quotations 264Examples of Price Quotes on OptionsContracts 265Uses of Options 266Protecting against Declining InvestmentYields 267Protecting against Rising InterestRates 267
Payoff Diagrams for ValuingOptions 267Options Offered on ExchangesToday 270
9.6 Exchanges Where Futures andOptions Contracts Are Traded 270
9.7 Risks, Costs, and Rules for Tradingin Derivatives 271Risks and Costs Associated withFutures and Options 271Accounting Rules for TransactionsInvolving Derivatives 271Summary of the Chapter's MainPoints 272Key Terms Appearing in ThisChapter 273
xxviii Contents
Problems and Issues 274Web-Based Problems 276Selected References to Explore 276Appendix 9A: The Black-ScholesModel for Valuing Options 278
PART 3
The Money Market and CentralBanking 281
10 Introduction to the Money Market andthe Roles Played by Governments andSecurity Dealers 28210.1 Introduction: The Market for
Short-Term Credit 28310.2 Characteristics of the Money
Market 283What the Money Market Does 283The Need for a Money Market 284Key Borrowers and Lenders in theMoney Market 284The Goals of Money MarketInvestors 286Types of Investment Risk ThatInvestors Face 287Money Market Maturities 289Depth and Breadth of the MoneyMarket 289The Speed of Money Market Payments:Federal Funds versus ClearinghouseFunds 289A Market for Large Borrowers andLenders 291
10.3 Government Involvement in theMoney Market 291The Roles That Governments Play inthe Money Market 291Selling Treasury Bills to MoneyMarket Investors: The Anchor of theMoney Market 292Volume of Bills Outstanding 292Types of Treasury Bills 292How Bills Are Sold 293Results of a Recent Bill Auction 295Market Interest Rates on TreasuryBills 295Investors in Treasury Bills 297
10.4 Primary Dealers in GovernmentSecurities 297
10.5 Dealer Borrowing and LendingActivities in the Money Market 299Demand Loans for Dealers 299Repurchase Agreements (RPs) forDealers and Other Money MarketParticipants 300A New Type of RP: The GCF Repo 301Sources of Dealer Income 302Dealer Positions in Securities 303Dealer Transactions and GovernmentSecurity Brokers 304Summary of the Chapter's MainPoints 306Key Terms Appearing in ThisChapter 307Problems and Issues 307Web-Based Problems 308Selected References to Explore 309
11 Commercial Banks, Major Corporations,and Federal Credit Agencies in theMoney Market 31111.1 Introduction 31211.2 The Roles Played by Banks in the
Money Market 31211.3 Federal Funds Provided by the
Banking System 313The Nature of Federal Funds andTheir Uses 313
r Use of the Federal Funds Market toMeet Reserve Requirements 314Mechanics of Federal Funds Trading 314Volume of Borrowings in the FundsMarket 316Interest Rates on Federal Funds 316Federal Funds and GovernmentEconomic Policy 316
11.4 Negotiable Certificates of Deposit(CDs) Issued by Banks 318Terms Attached to CDs and WhoBuys Them 318Buyers of CDs 320New Types of CDs 321
11.5 Eurocurrency Deposits inInternational Banks 322What Is a Eurodollar? 322The Creation of EurocurrencyDeposits 323
Contents
Eurocurrency Maturities andRisks 326The Supply of EurocurrencyDeposits 326Eurodollars in U.S Domestic BankOperations 327Recent Innovations in theEurocurrency Markets 328Benefits and Costs of theEurocurrency Markets 328
11.6 Bankers' Acceptances 328How Bankers' Acceptances Are Usedin International Trade 328Bankers' Acceptances as InvestmentInstruments 329The Decline in Bankers'Acceptances 330
11.7 Evaluating the Money MarketCosts of Funds Needed byBankers 331
11.8 Concluding Comment on BankActivity in the Money Market 332
11.9 Major Corporations in the MoneyMarket: Commercial Paper 333The Nature of Commercial Paper 333Types of Commercial Paper 333The Recent Track Record ofCommercial Paper 335Commercial Paper as InvestmentInstruments 336Advantages of Issuing CommercialPaper 338Possible Disadvantages from IssuingCommercial Paper 339Who Buys Commercial Paper? 339Continuing Innovations in the PaperMarket 340Commercial Paper Ratings and DealerOperations 341Dealers in Paper 341
11.10 Credit Agencies in the MoneyMarket 342Types of Federal CreditAgencies 342Growth of the Agency SecurityMarket 343Characteristics and Marketing ofAgency Securities 346
Summary of the Chapter's MainPoints 346Key Terms Appearing in ThisChapter 348Problems and Issues 348Web-Based Problems 351Selected References to Explore 352
12 Roles and Services of the FederalReserve and Other Central Banks aroundthe World 35412.1 Introduction to Central
Banking 35512.2 The Roles of Central Banks in the
Economy and Financial System 355Control of the Money Supply toAvoid Severe Inflation 355Stabilizing the Money and CapitalMarkets 356Lender of Last Resort and Supervisorof the Banking System 357Maintaining and Improving thePayments Mechanism 357
12.3 The Goals and Channels of CentralBanking 357Central Banks' Goals 357Challenges in Achieving Central BankGoals 358The Channels through Which CentralBanks Work 359
12.4 History of the Federal ReserveSystem—Central Bank of theUnited States 362Problems in the Early U.S. BankingSystem 362Creation of the Federal ReserveSystem 363The Early Structure of the FederalReserve 364Goals and Policy Tools of theFed 364
12.5 How the Fed Is OrganizedToday 365The Board of Governors 366The Federal Open MarketCommittee 367The Federal Reserve Banks 368The Member Banks of the FederalReserve System 370
Contents
13
12.6 Roles of the Federal ReserveSystem Today 372The Clearing and Collection of Checksand Other Payments Media 372Issuing Currency and Coin andRelated Services 373Maintaining a Sound Banking andFinancial System 373Serving as the Federal Government'sFiscal Agent 373Providing Information to the Public 374Carrying Out Monetary Policy 374
12.7 The Key Focus of Central BankMonetary Policy: Interest Rates,Reserves, and Money 374
12.8 Reserve Composition andthe Deposit and MoneyMultipliers 375The Deposit Multiplier 376The Money Multiplier 378Summary of the Chapter's MainPoints 380
Key Terms Appearing in ThisChapter 381Problems and Issues 381Web-Based Problems 382Selected References toExplore 383
The Tools and Goals of Central BankMonetary Policy 38413.1 Introduction to the Tools and Goals
of Monetary Policy 38513.2 General versus Selective Credit
Controls 38513.3 General Credit Controls in Central
Banking 385Open Market Operations 385Effects of Open Market Operations onInterest Rates 385
Effects of Open Market Operations onReserves 386
How Open Market Operations AreConducted in the United States 387
Types of Open Market Operations 389
Goals of Open Market Operations:Defensive and Dynamic 392
Changes in the Federal Reserve'sDiscount Rate 394
Borrowing and Repaying DiscountWindow Loans 396
Effects of a Discount RateChange 397
Reserve Requirements 398
Effects of a Change in Deposit ReserveRequirements 399
An Illustration 400
Current Levels of ReserveRequirements 400
13.4 Selective Credit Controls Used inCentral Banking 403Moral Suasion by Central BankOfficials 403
Margin Requirements 403
13.5 Interest Rate Targeting 404The Federal Funds Rate 404
Fed Funds Targeting and Long-TermInterest Rates 407
13.6 The Federal Reserve and EconomicGoals 408
The Goal of ControllingInflation 408
Central Bank Targeting ofInflation 410
Deflation 411
Hyperinflation 411
The Goals of Full Employment andStable Economic Growth 412The Natural Rate ofUnemployment 412
The Output Gap 413
13.7 The Conflicting Goals andthe Limitations of MonetaryPolicy 414
Summary of the Chapter's MainPoints 416
Key Terms Appearing in ThisChapter 418
Problems and Issues 418
Web-Based Problems 419Selected References toExplore 419
Contents xxxi
PART 4
Financial Institutions: Organization,Activities, and Regulation 421
14 The Commercial BankingIndustry: Structure, Products, andManagement 42214.1 Introduction to Banking 42314.2 The Structure of U.S. Commercial
Banking 423A Trend toward Consolidation 424Falling Industry Numbers As SmallBanks Are Taken Over by LargerOnes 424
A Countertrend: Both Small andLarge Banks May Survive 425Economies of Scale Support aConsolidating Industry 425Branch Banking 425Bank Holding Companies(BHCs) 426Financial Holding Companies(FHCs) 427International Banking 427
14.3 The Convergence Trend inBanking 429Bank Failures 429Changing Technology 430
14.4 Portfolio Characteristics ofCommercial Banks 432Balance Sheet Items 432
Cash and Due from Banks (PrimaryReserves) 432
Investment Security Holdings andSecondary Reserves 434
Loans 434
Loan Loss Allowances andrLoanRisk 435Deposits 436
Nondeposit Sources of Funds 437
Equity Capital 439Income Statement Items 439Revenues and Expenses 439
Interest and Noninterest Margins 440
15
14.5 Managing Commercial BankPerformance Today 441Managing Bank Assets, Liabilities,Revenues, and Expenses 441Monitoring the Performance of aBank 442
14.6 Money Creation and Destructionby Banks and Bank AccountingMethods 445The Creation of Money andCredit 446
Destruction of Deposits andReserves 448
Implications of Money Creation andDestruction 448
Summary of the Chapter's MainPoints 450
Key Terms Appearing in ThisChapter 451Problems and Issues 451Web-Based Problems 453Selected References toExplore 454
N on bank Thrift Institutions: Savings andLoans, Savings Banks, Credit Unions,and Money Market Funds 45615.1 Introduction to Thrift
Institutions 45715.2 Savings and Loan Associations
(S&Ls) 457Origins of S&Ls 457
How Funds Are Raised andAllocated 458Asset Portfolios 458
Liabilities of S&Ls 459
Trends in Revenues and Costs 460Possible Ways to Strengthen the S&LIndustry in the Future 462
15.3 Savings Banks (SBs) 464Number and Distribution ofSavings Banks and RegulatorySupervision 464
How Funds Are Raised andAllocated 465
Current Trends and FutureProblems 466
Contents
15.4 Credit Unions (CUs) 467Credit Union Membership 469Size of Credit Unions 469New Services Offered 470A Strong Competitive Force 472
15.5 Money Market Funds (MMFs) 472Summary of the Chapter's MainPoints 476Key Terms Appearing in ThisChapter 477Problems and Issues 477Web-Based Problems 478Selected References to Explore 479
16 Mutual Funds, Insurance Companies,Investment Banks, and Other FinancialFirms 48116.1 Introduction 48216.2 Mutual Funds (or Investment
Companies) 482The Background of InvestmentCompanies 482Bonds and Money Market Funds 482Stock Funds 483Index and Exchange-TradedFunds 483Global and Vulture Funds 484Small-Cap to Large-Cap Funds 485Life-Cycle Funds 485Hedge Funds 485Tax and Regulatory Status of theIndustry 485Open-End and Closed-End InvestmentCompanies 486Changing Investment Strategies 487Goals and Earnings of InvestmentCompanies 487Scandal Envelops the Mutual FundIndustry 488
16.3 Pension Funds 489Types of Pension Funds 489Defined-Benefit and ContributionPlans 490
Cash-Balance Pension Funds 490Growth of Pension Funds 491Investment Strategies of PensionFunds 492
Pension Fund Assets 493Factors Affecting the Future Growthof Pension Funds 495
16.4 Life Insurance Companies 496The Insurance Principle 498Investments of Life InsuranceCompanies 498Sources of Life Insurance CompanyFunds 500Structure and Growth of the LifeInsurance Industry 501New Services 502
16.5 Property-Casualty InsuranceCompanies 503Makeup of the Property-Casualty(P/C) Insurance Industry 503Changing Risk Patterns in Property/Liability Coverage 504Investments by Property-Casualty(P/C) Companies 506Sources of Income 507Business Cycles, Inflation, andCompetition 507
16.6 Finance Companies 508Different Finance Companies forDifferent Purposes 508Growth of Finance Companies 510Methods of Industry Financing 510Recent Changes in the Character ofthe Finance Company Industry 510Consolidation in the Industry 510New Types of FinanceCompanies 511
16.7 Investment Banks 511The Underwriting Function ofInvestment Banks 511Other Investment BankingServices 512
Leading Investment Banks and theConvergence of Commercial andInvestment B anking 512
16.8 Other Important FinancialInstitutions 512
16.9 Trends Affecting All FinancialInstitutions Today 514Summary of the Chapter's MainPoints 516
Contents XXXIII
Key Terms Appearing in ThisChapter 517Problems and Issues 518Web-Based Problems 519Selected References toExplore 520
Regulation of the Financial Institutions'Sector 52217.1 Introduction to Financial
Institutions' Regulation 52317.2 The Reasons behind the
Regulation of FinancialInstitutions 523Does Regulation Benefit or HarmFinancial Institutions? 525
17.3 The Regulation of CommercialBanks 527The Federal Reserve System(The Fed) 527Office of the Comptroller of theCurrency (The OCC) 527Federal Deposit InsuranceCorporation (FDIC) 529State Banking Commissions 530Opening Competition across PoliticalBoundaries 530Regulation of the Services Banks CanOffer 533The Gramm-Leach-Bliley (GLB)Act 534The Rise of Disclosure and PrivacyLaws in Banking 535The Growing Importance ofCapital Regulation inBanking 536
Basel I 536Basel II 538The Unfinished Agenda for BankingRegulation 539
17.4 The Regulation of ThriftInsitutions 540Credit Unions 541Savings and Loans 542Savings Banks 544Money Market Funds 544
17.5 The Regulation of InsuranceCompanies 544
17.6 The Regulation of PensionFunds 545
17.7 The Regulation of FinanceCompanies 546
17.8 The Regulation of Invest-mentCompanies (Mutual Funds) 547
17.9 An Overview of Trends inthe Regulation of FinancialInstitutions 547Summary of the Chapter's MainPoints 551Key Terms Appearing in ThisChapter 552Problems and Issues 552Web-Based Problems 553Selected References to Explore 555
PART 5
Governments and Businesses in theFinancial Markets 557
18 Federal, State, and Local GovernmentsOperating in the Financial Markets 558
18.1 Introduction to the Role ofGovernments in the FinancialMarketplace 559
18.2 Federal Government Activityin the Money and CapitalMarkets 559The Treasury Department in theFinancial Marketplace 559
The Fiscal Policy Activities of theU.S. Treasury 559
Sources of Federal GovernmentFunds 560Federal Government Expenditures 562Effects of Government Borrowingon the Financial System and theEconomy 562
Management of the FederalDebt 565The Size and Growth of the PublicDebt 566The Composition of the PublicDebt 568
xxxiv Contents
Marketable Public Debt 568
Nonmarketable Public Debt 569
Investors in U.S. GovernmentSecurities 569
Methods of Offering TreasurySecurities 571The Auction Method 572
Types of Treasury Auctions 572
Marketing Techniques 572
Book Entry 573
Other Services Offered Investors 573
On-the-Run and Off-the-Run TreasurySecurities 573
Treasury Interest Rates as GlobalBenchmarks for Other InterestRates 573
The Goals of Federal DebtManagement 574Minimize Interest Costs 574Economic Stabilization 574The Impact of Federal DebtManagement on the Financial Marketsand the Economy 574
18.3 State and Local Governments in theFinancial Markets 576Growth of State and LocalGovernment Borrowing 576Sources of Revenue for State andLocal Governments 578State and Local GovernmentExpenditures 579Motivations for State and LocalGovernment Borrowing 581Types of Securities Issued by Stateand Local Governments 582Short-Term Securities 583Long-Term Securities 583Types of Revenue Bonds 584Innovations in MunicipalSecurities 584
Key Features of Municipal Debt 585Tax Exemption 585Exemption Contributes to MarketVolatility 587Credit Ratings 588
Serialization 590
How Municipal Bonds AreMarketed 591Problems in the MunicipalMarket 592Summary of the Chapter's MainPoints 594Key Terms Appearing in ThisChapter 596Problems and Issues 596Web-Based Problems 598Selected References toExplore 599
19 Business Borrowing: CorporateBonds, Asset-Backed Securities, BankLoans, and Other Forms of BusinessDebt 60119.1 Introduction to Business
Borrowing 60219.2 Factors Affecting Business
Activity in the Money and CapitalMarkets 602
19.3 Characteristics of Corporate Notesand Bonds 603Principal Features of Corporate Notesand Bonds 603Recent Trends in Original Maturitiesof Corporate Bonds 604Call Privileges Attached to CorporateBonds 604Sinking Fund Provisions 604Yields and Costs of CorporateBonds 605Signals Corporate Bond IssuesMay Send to the FinancialMarketplace 606The Most Common Types ofCorporate Bonds 606Debentures 606
Subordinated Debentures 607
Mortgage Bonds 607
Income Bonds 607
Equipment Trust Certificates 607
Industrial Development Bonds 607
Innovations in Corporate Debt 608
Contents
19.4 Asset-Backed Securities Issued byCorporations 609
19.5 Investors in Corporate Debt 61219.6 The Secondary Market for
Corporate Debt 61419.7 The Marketing of Corporate
Debt 614Public Sales 614Private Placements 617
19.8 The Volume of Borrowing byCorporations 619
19.9 Bank Loans to BusinessFirms 621The Volume of Bank Credit Suppliedto Businesses 621The Prime, or Base, Interest Rate onBusiness Loans 622Other Examples of Base Rates forBusiness Loans 623
19.10 Commercial Mortgages 623Summary of the Chapter's MainPoints 625Key Terms Appearing in ThisChapter 626Problems and Issues 626Web-Based Problems 628Selected References to Explore 629
D The Market for Corporate Stock 63020.1 Introduction to the Stock
Market 63120.2 Characteristics of Corporate
Stock 631Common Stock 631Preferred Stock 632
20.3 Stock Market Investors 63420.4 Equity as a Source of
Funding 63820.5 The Process of Price Discovery in
the Equity Markets 640Organized Exchanges 640Foreign Exchanges 642Contributions of Exchanges 642Over-the-Counter (OTC)Markets 642Evolving Trading Platforms 643
20.6 The Third Market: Tradingin Listed Securities off theExchanges 644
20.7 The Private Equity Market 64720.8 Investment Banking and the Sale of
New Stock 64720.9 The Development of a Unified
International Market forStock 649The National Market System 649NASD and Automated PriceQuotations 649The Advent of ShelfRegistration 650Global Trading in Equities 650The Development of ADRs 651
20.10 Valuing Stocks: AlternativeApproaches 652Technical and FundamentalAnalysis 652Private Information 653Summary of the Chapter's MainPoints 654Key Terms Appearing in ThisChapter 655Problems and Issues 656Web-Based Problems 656Selected References toExplore 657
PART 6
Consumers in the FinancialMarkets 659
21 Consumer Lending andBorrowing 66021.1 Introduction to Consumer Lending
and Borrowing 66121.2 Consumers as Lenders of
Funds 661Financial Assets Purchased byConsumers 661Recent Innovations in ConsumerSavings Instruments 663
Contents
21.3 Consumers as Borrowers ofFunds 666
Is Consumer BorrowingExcessive? 666Categories of ConsumerBorrowing 668
21.4 Home Equity Loans 66921.5 Credit and Debit Cards 670
Credit Cards 671
Debit Cards 672
21.6 The Determinants of ConsumerBorrowing 673
21.7 Consumer LendingInstitutions 674Commercial Banks 675Finance Companies 675Other Consumer Lenders: CreditUnions, Savings Associations, andSmall Loan Companies 675
21.8 Factors Considered in MakingConsumer Loans 676
21.9 Credit Scoring Techniques 677
21.10 Financial Disclosure and ConsumerCredit 678Truth in Lending 678
Fair Credit Billing Act 679Fair Credit Reporting Act 679
Consumer Leasing Act 680
Competitive Banking Equality Act 680Fair Credit and Charge CardDisclosure Act 680Truth in Savings Act 680The Financial Services Modernization(Gramm-Leach-Bliley) Act 681Identity Theft 681
21.11 Credit Discrimination Laws 682Community Reinvestment Actand Financial Institutions Reform,Recovery, and Enforcement Act 682Equal Credit Opportunity Act 682Fair Housing and Home MortgageDisclosure Acts 682
21.12 Bankruptcy Law Changes 683Summary of the Chapter's Main
• Points 684
Key Terms Appearing in ThisChapter 685Problems and Issues 686Web-Based Problems 687Selected References to Explore 688
22 The Residential Mortgage Market 690
22.1 Introduction to the ResidentialMortgage Market 691
22.2 Recent Trends in New HomePrices and the Terms of MortgageLoans 691
22.3 The Structure of the MortgageMarket 693Volume of Mortgage Loans 693Residential versus NonresidentialMortgage Loans 693
22.4 Mortgage-LendingInstitutions 694
22.5 The Roles Played by LeadingFinancial Institutions in theMortgage Market 696Savings and Loan Associations 697
Commercial Banks 697
Life Insurance Companies 697
Savings Banks 698
Mortgage Bankers 698
22.6 Government Activity in theMortgage Market 698The Impact of the Great Depressionon Government Involvement in theMortgage Market 698Launching the Federal Home LoanBank System 699Setting Up the Federal HousingAdministration (FHA) and theVeterans Administration (VA) 699The Creation of Fannie Mae—AGovernment-Sponsored Enterprise(GSE) 700
The Creation of Ginnie Mae(GNMA) 700GNMA Mortgage-BackedSecurities 701
The Federal Home Loan MortgageCorporation—Another Government-Sponsored Enterprise (GSE) 701
Contents
FHLMC Mortgage-BackedSecurities 701Freddie and Fannie Face NewProblems 701Collateralized Mortgage Obligations(CMOs) and Real Estate MortgageInvestment Conduits (REMICs) 702Impact of Securitized Mortgages 702
22.7 Innovations in MortgageInstruments 703Fixed-Rate Home Mortgages—TheOldest Form of Home Loan 703Variable-Rate and AdjustableMortgage Instruments 704Interest-Only Mortgages 704Reverse-Annuity Mortgages 705 x
Epilogue on the Fixed-RateMortgage 705
22.8 Pricing and Other Issues in HomeMortgage Lending 705Pricing Home Mortgages and theTreasury Security Market 705Mortgage Lock-Ins, LoanModifications, and Foreclosures 707Refinancing Home Mortgages and"Cash Outs" 707Predatory Lending 708Summary of the Chapter's MainPoints 709Key Terms Appearing in ThisChapter 711Problems and Issues 711Web-Based Problems 712Selected References toExplore 713
PART 7
The International FinancialSystem 715
23 International Transactions and CurrencyValues 71623.1 Introduction to International
Transactions and CurrencyValues 717
23.2 The Balance-of-Payments (BOP)Accounts 717The U.S. Balance of InternationalPayments 718The Current Account 719The Merchandise Trade Balance in theCurrent A ccount 719
The Service Balance in the CurrentAccount 720
Investment Income Receiptsand Payments in the CurrentAccount 721
Compensation of Employees in theCurrent Account 721
Unilateral Transfers in the CurrentAccount 721
The Balance on Current Account 721
The Capital and FinancialAccounts 722Official Transactions 722Disequilibrium in the Balance ofPayments 723
23.3 The Problem of Different MonetaryUnits in International Trade andFinance 724The Gold Standard 724The Gold Exchange Standard 725The Modified ExchangeStandard 725The Managed Floating CurrencyStandard 726
23.4 Determining Foreign CurrencyValues 728Essential Features of the ForeignExchange Market 729Exchange Rate Quotations 729Factors Affecting Foreign ExchangeRates 731BOP Position 731
Speculation 731
Domestic Political and Economic
Conditions 731
Purchasing Power Parity 731
Central Bank Intervention 732
Supply and Demand for ForeignExchange 732
xxxviii Contents
24
23.5 The Forward Market forCurrencies 735Methods of Quoting ForwardExchange Rates 735
23.6 Functions of the Forward ExchangeMarket 736Commercial Covering 736Hedging an Investment Position 737Speculation on Future CurrencyPrices 737Covered Interest Arbitrage 737The Principle of Interest RateParity 738
23.7 The Market for Foreign CurrencyFutures 739The Buying Hedge 740
The Selling Hedge 740
23.8 Other Innovative Methods forDealing with Currency Risk 740
23.9 Government Intervention in theForeign Exchange Markets 742Summary of the Chapter's MainPoints 743Key Terms Appearing in ThisChapter 744Problems and Issues 745Web-Based Problems 746Selected References to Explore 747
International Banking 74824.1 Introduction to International
Banking 74924.2 The Scope of International Banking
Activities 749Multinational BankingCorporations 749Types of Facilities Operated by BanksAbroad 749
1 Choosing the Right Kind of Facility toServe Foreign Markets 750
24.3 Services Offered by InternationalBanks 751Issuing Letters of Credit 751Buying and Selling Foreign Exchange(FOREX) 751
Accepting Eurocurrency Deposits andMaking Eurocurrency Loans 751Marketing and Underwriting of BothDomestic and Eurocurrency Bonds,Notes, and Equity Shares 751Securitizing Loans 753Advisory Services Provided byInternational Banks 753Universal Banking Services andOne-Stop Shopping 754
24.4 Foreign Banks Operating in theUnited States 754The Growth of Foreign Bank Activityin the United States 755Federal Regulation of Foreign BankActivity 755
24.5 Regulation of the InternationalBanking Activities of U.S.Banks 756
24.6 The Future of InternationalBanking 757The Risks of InternationalLending 757Political and Currency Risk 757Geographic Distribution ofInternational Bank Lending 759Public Confidence and ProtectingAgainst Bank Failures 759The Spread of Deregulation: HowFast Should We Go? 761
24.7 Prospects and Challenges for theTwenty-First Century 762Summary of the Chapter's MainPoints 763Key Terms Appearing in ThisChapter 765Problems and Issues 765Web-Based Problems 766Selected References to Explore 767
Money and Capital Markets Dictionary D-1Index 1-1
top related