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The Prentice Hall Series in Finance, ii
Copyright, iv
Contents on the Web, xxvii
Preface, xxix
About the Authors, xxxix
Part One. Introduction, 1
Chapter 1. Why Study Financial Markets and Institutions?, 3
Preview, 3
Why Study Financial Markets?, 4
Debt Markets and Interest Rates, 4
The Stock Market, 5
The Foreign Exchange Market, 6
Why Study Financial Institutions?, 8
Central Banks and the Conduct of Monetary Policy, 8
Structure of the Financial System, 8
Banks and Other Financial Institutions, 8
Financial Innovation, 9
Managing Risk in Financial Institutions, 9
Applied Managerial Perspective, 9
How We Will Study Financial Markets and Institutions, 10
Exploring the Web, 11
Collecting and Graphing Data, 11
Web Exercise, 11
Concluding Remarks, 14
Summary, 14
Key Terms, 14
Questions, 15
Quantitative Problems, 15
Web Exercises: Working with Financial Market Data, 16
Chapter 2. Overview of the Financial System, 17
Preview, 17
Function of Financial Markets, 18
Structure of Financial Markets, 20
Debt and Equity Markets, 20
Primary and Secondary Markets, 20
Exchanges and Over-the-Counter Markets, 21
Money and Capital Markets, 22
Internationalization of Financial Markets, 22
International Bond Market, Eurobonds, and Eurocurrencies, 22
Global: Are U.S. Capital Markets Losing Their Edge?, 23
World Stock Markets, 24
Function of Financial Intermediaries: Indirect Finance, 24
Following the Financial News: Foreign Stock Market Indexes, 25
Transaction Costs, 25
Global: The Importance of Financial Intermediaries Relative to Securities Markets: An International Comparison, 26
Risk Sharing, 27
Asymmetric Information: Adverse Selection and Moral Hazard, 27
Types of Financial Intermediaries, 29
Depository Institutions, 29
Contractual Savings Institutions, 30
Investment Intermediaries, 32
Regulation of the Financial System, 33
Increasing Information Available to Investors, 33
Ensuring the Soundness of Financial Intermediaries, 34
Financial Regulation Abroad, 35
Summary, 36
Key Terms, 36
Questions, 37
Web Exercises: The Financial System, 37
Part Two. Fundamentals of Financial Markets, 39
Chapter 3. What Do Interest Rates Mean and What Is Their Role in Valuation?, 41
Preview, 41
Measuring Interest Rates, 42
Present Value, 42
Four Types of Credit Market Instruments, 44
Yield to Maturity, 45
Global: Negative T-Bill Rates? Japan Shows the Way, 52
The Distinction Between Real and Nominal Interest Rates, 52
The Distinction Between Interest Rates and Returns, 55
Mini-Case: With TIPS, Real Interest Rates Have Become Observable in the United States, 56
Maturity and the Volatility of Bond Returns: Interest-Rate Risk, 59
Mini-Case: Helping Investors Select Desired Interest-Rate Risk, 59
Reinvestment Risk, 60
Summary, 60
The Practicing Manager: Calculating Duration to Measure Interest-Rate Risk, 61
Calculating Duration, 62
Duration and Interest-Rate Risk, 66
Summary, 67
Key Terms, 68
Questions, 68
Quantitative Problems, 68
Web Exercises: Understanding Interest Rates, 70
Chapter 4. Why Do Interest Rates Change?, 71
Preview, 71
Determinants of Asset Demand, 71
Wealth, 72
Expected Returns, 72
Risk, 73
Liquidity, 75
Summary, 75
Supply and Demand in the Bond Market, 75
Demand Curve, 76
Supply Curve, 77
Market Equilibrium, 78
Supply and Demand Analysis, 79
Changes in Equilibrium Interest Rates, 79
Shifts in the Demand for Bonds, 80
Shifts in the Supply of Bonds, 83
Case: Changes in the Interest Rate Due to Expected Inflation: The Fisher Effect, 86
Case: Changes in the Interest Rate Due to a Business Cycle Expansion, 87
Case: Explaining Low Japanese Interest Rates, 89
Case: Reading the Wall Street Journal “Credit Markets” Column, 90
Following the Financial News: The “Credit Markets” Column, 91
The Practicing Manager: Profiting from Interest-Rate Forecasts, 92
Following the Financial News: Forecasting Interest Rates, 93
Summary, 94
Key Terms, 95
Questions, 95
Quantitative Problems, 96
Web Exercises: Interest Rates and Inflation, 97
Chapter 5. How Do Risk and Term Structure Affect Interest Rates?, 99
Preview, 99
Risk Structure of Interest Rates, 99
Default Risk, 100
Case: The Enron Bankruptcy and the Baa–Aaa Spread, 103
Liquidity, 104
Income Tax Considerations, 104
Summary, 105
Case: Effects of the Bush Tax Cut on Bond Interest Rates, 106
Term Structure of Interest Rates, 107
Following the Financial News: Yield Curves, 107
Expectations Theory, 109
Market Segmentation Theory, 113
Liquidity Premium Theory, 114
Mini-Case: The Yield Curve as a Forecasting Tool for Inflation and the Business Cycle, 118
Evidence on the Term Structure, 118
Summary, 119
Case: Interpreting Yield Curves, 1980–2008, 119
The Practicing Manager: Using the Term Structure to Forecast Interest Rates, 120
Summary, 124
Key Terms, 124
Questions, 124
Quantitative Problems, 125
Web Exercises: The Risk and Term Structures of Interest Rates, 126
Chapter 6. Are Financial Markets Efficient?, 127
Preview, 127
The Efficient Market Hypothesis, 128
Rationale Behind the Hypothesis, 130
Stronger Version of the Efficient Market Hypothesis, 131
Evidence on the Efficient Market Hypothesis, 131
Evidence in Favor of Market Efficiency, 131
Mini-Case: An Exception That Proves the Rule: Ivan Boesky, 133
Case: Should Foreign Exchange Rates Follow a Random Walk?, 135
Evidence Against Market Efficiency, 135
Overview of the Evidence on the Efficient Market Hypothesis, 137
The Practicing Manager: Practical Guide to Investing in the Stock Market, 138
How Valuable Are Published Reports by Investment Advisers?, 138
Mini-Case: Should You Hire an Ape as Your Investment Adviser?, 138
Should You Be Skeptical of Hot Tips?, 139
Do Stock Prices Always Rise When There Is Good News?, 139
Efficient Markets Prescription for the Investor, 140
Case: What Do the Black Monday Crash of 1987 and the Tech Crash of 2000 Tell Us About the Efficient Market Hypothesis?, 141
Behavioral Finance, 142
Summary, 143
Key Terms, 143
Questions, 143
Quantitative Problems, 144
Web Exercises: The Efficient Market Hypothesis, 144
Part Three. Central Banking and the Conduct of Monetary Policy, 145
Chapter 7. Structure of Central Banks and the Federal Reserve System, 147
Preview, 147
Origins of the Federal Reserve System, 147
Inside the Fed: The Political Genius of the Founders of the Federal Reserve System, 148
Structure of the Federal Reserve System, 149
Federal Reserve Banks, 150
Inside the Fed: The Special Role of the Federal Reserve Bank of New York, 151
Member Banks, 152
Board of Governors of the Federal Reserve System, 153
Inside the Fed: The Role of the Research Staff, 154
Federal Open Market Committee (FOMC), 155
The FOMC Meeting, 155
Inside the Fed: Green, Blue, and Beige: What Do These Colors Mean at the Fed?, 156
Why the Chairman of the Board of Governors Really Runs the Show, 156
How Independent Is the Fed?, 157
Structure and Independence of the European Central Bank, 158
Differences Between the European System of Central Banks and the Federal Reserve System, 159
Governing Council, 159
How Independent Is the ECB?, 160
Structure and Independence of Other Foreign Central Banks, 161
Bank of Canada, 161
Bank of England, 161
Bank of Japan, 162
The Trend Toward Greater Independence, 162
Explaining Central Bank Behavior, 163
Inside the Fed: Federal Reserve Transparency, 163
Should the Fed Be Independent?, 164
The Case for Independence, 164
The Case Against Independence, 165
Central Bank Independence and Macroeconomic Performance Throughout the World, 166
Summary, 166
Key Terms, 167
Questions and Problems, 167
Web Exercises: The Structure of the Federal Reserve System, 168
Chapter 8. Conduct of Monetary Policy: Tools, Goals, Strategy, and Tactics, 169
Preview, 169
The Federal Reserve’s Balance Sheet, 169
Liabilities, 170
Assets, 171
Open Market Operations, 171
Discount Lending, 172
The Market for Reserves and the Federal Funds Rate, 173
Demand and Supply in the Market for Reserves, 173
How Changes in the Tools of Monetary Policy Affect the Federal Funds Rate, 174
Tools of Monetary Policy, 176
Open Market Operations, 177
A Day at the Trading Desk, 178
Discount Policy, 179
Operation of the Discount Window, 179
Lender of Last Resort, 180
Inside the Fed: Using Discount Policy to Prevent a Financial Panic, 182
Reserve Requirements, 183
Monetary Policy Tools of the European Central Bank, 183
Open Market Operations, 184
Lending to Banks, 184
Reserve Requirements, 184
The Price Stability Goal and the Nominal Anchor, 185
The Role of a Nominal Anchor, 185
The Time-Inconsistency Problem, 185
Other Goals of Monetary Policy, 186
High Employment, 186
Economic Growth, 187
Stability of Financial Markets, 187
Interest-Rate Stability, 188
Stability in Foreign Exchange Markets, 188
Should Price Stability Be the Primary Goal of Monetary Policy?, 188
Hierarchical Versus Dual Mandates, 189
Price Stability as the Primary, Long-Run Goal of Monetary Policy, 189
Monetary Targeting, 190
Monetary Targeting in the United States, Japan, and Germany, 190
Global: The European Central Bank’s Monetary Policy Strategy, 193
Advantages of Monetary Targeting, 193
Disadvantages of Monetary Targeting, 194
Inflation Targeting, 194
Inflation Targeting in New Zealand, Canada, and the United Kingdom, 194
Advantages of Inflation Targeting, 196
Disadvantages of Inflation Targeting, 197
Inside the Fed: The New Fed Chairman and Inflation Targeting, 199
Tactics: Choosing the Policy Instrument, 199
Criteria for Choosing the Policy Instrument, 202
The Practicing Manager: Using a Fed Watcher, 203
Summary, 204
Key Terms, 205
Questions, 205
Quantitative Problems, 206
Web Exercises: Conduct of Monetary Policy, 207
Part Four. Financial Markets, 209
Chapter 9. The Money Markets, 211
Preview, 211
The Money Markets Defined, 211
Why Do We Need the Money Markets?, 212
Money Market Cost Advantages, 213
The Purpose of the Money Markets, 214
Who Participates in the Money Markets?, 215
U.S. Treasury Department, 215
Federal Reserve System, 215
Commercial Banks, 215
Businesses, 216
Investment and Securities Firms, 216
Individuals, 217
Money Market Instruments, 217
Treasury Bills, 218
Case: Discounting the Price of Treasury Securities to Pay the Interest, 218
Mini-Case: Treasury Bill Auctions Go Haywire, 220
Federal Funds, 222
Repurchase Agreements, 223
Negotiable Certificates of Deposit, 224
Commercial Paper, 224
Banker’s Acceptances, 227
Eurodollars, 229
Global: Ironic Birth of the Eurodollar Market, 229
Comparing Money Market Securities, 230
Interest Rates, 230
Liquidity, 231
Following the Financial News: Money Market Rates, 232
How Money Market Securities Are Valued, 233
Summary, 234
Key Terms, 234
Questions, 235
Quantitative Problems, 235
Web Exercises: The Money Markets, 236
Chapter 10. The Bond Market, 237
Preview, 237
Purpose of the Capital Market, 237
Capital Market Participants, 238
Capital Market Trading, 238
Types of Bonds, 239
Treasury Notes and Bonds, 240
Treasury Bond Interest Rates, 240
Treasury Inflation Protected Securities (TIPS), 240
Treasury STRIPS, 242
Agency Bonds, 242
Municipal Bonds, 243
Risk in the Municipal Bond Market, 244
Corporate Bonds, 244
Characteristics of Corporate Bonds, 245
Types of Corporate Bonds, 247
Financial Guarantees for Bonds, 250
Current Yield Calculation, 250
Current Yield, 250
Finding the Value of Coupon Bonds, 252
Finding the Price of Semiannual Bonds, 252
Investing in Bonds, 255
Summary, 256
Key Terms, 256
Questions, 256
Quantitative Problems, 257
Web Exercise: The Bond Market, 258
Chapter 11. The Stock Market, 259
Preview, 259
Investing in Stocks, 259
Common Stock Versus Preferred Stock, 260
How Stocks Are Sold, 261
Computing the Price of Common Stock, 265
The One-Period Valuation Model, 265
The Generalized Dividend Valuation Model, 266
The Gordon Growth Model, 267
Price Earnings Valuation Method, 268
How the Market Sets Security Prices, 269
Errors in Valuation, 270
Problems with Estimating Growth, 270
Problems with Estimating Risk, 271
Problems with Forecasting Dividends, 271
Case: The September 11 Terrorist Attack, the Enron Scandal, and the Stock Market, 272
Stock Market Indexes, 272
Mini-Case: History of the Dow Jones Industrial Average, 273
Buying Foreign Stocks, 275
Regulation of the Stock Market, 275
The Securities and Exchange Commission, 275
Summary, 276
Key Terms, 277
Questions, 277
Quantitative Problems, 277
Web Exercises: The Stock Market, 279
Chapter 12. The Mortgage Markets, 281
Preview, 281
What Are Mortgages?, 282
Characteristics of the Residential Mortgage, 283
Mortgage Interest Rates, 283
Case: The Discount Point Decision, 284
Loan Terms, 285
Mortgage Loan Amortization, 287
Case: Computing the Payment on Mortgage Loans, 288
Types of Mortgage Loans, 289
Insured and Conventional Mortgages, 289
Fixed- and Adjustable-Rate Mortgages, 290
Other Types of Mortgages, 290
Mortgage-Lending Institutions, 293
Loan Servicing, 294
E-Finance: Borrowers Shop the Web for Mortgages, 294
Secondary Mortgage Market, 295
Securitization of Mortgages, 295
What Is a Mortgage-Backed Security?, 296
Mini-Case: Are Fannie Mae and Freddie Mac Getting Too Big for Their Britches?, 296
Types of Pass-Through Securities, 297
Mortgage-Backed Securities Clearing Corporation, 298
The Impact of Securitized Mortgages on the Mortgage Market, 299
Subprime Mortgages, 299
Summary, 300
Key Terms, 301
Questions, 301
Quantitative Problems, 302
Web Exercises: The Mortgage Markets, 303
Chapter 13. The Foreign Exchange Market, 305
Preview, 305
Foreign Exchange Market, 306
What Are Foreign Exchange Rates?, 307
Why Are Exchange Rates Important?, 307
Following the Financial News: Foreign Exchange Rates, 308
How Is Foreign Exchange Traded?, 308
Exchange Rates in the Long Run, 309
Law of One Price, 309
Theory of Purchasing Power Parity, 310
Why the Theory of Purchasing Power Parity Cannot Fully Explain Exchange Rates, 311
Factors That Affect Exchange Rates in the Long Run, 311
Exchange Rates in the Short Run, 313
Comparing Expected Returns on Domestic and Foreign Assets, 314
Interest Parity Condition, 316
Demand Curve for Domestic Assets, 317
Supply Curve for Domestic Assets, 319
Equilibrium in the Foreign Exchange Market, 319
Explaining Changes in Exchange Rates, 319
Shifts in the Demand for Domestic Assets, 319
Case: Changes in the Equilibrium Exchange Rate: Two Examples, 324
Changes in Interest Rates, 324
Changes in the Money Supply, 325
Exchange Rate Overshooting, 326
Case: Why Are Exchange Rates So Volatile?, 327
Case: The Dollar and Interest Rates, 1973–2007, 328
Case: The Euro’s First Nine Years, 329
Case: Reading the Wall Street Journal : The “Currency Trading” Column, 330
Following the Financial News: The “Currency Trading” Column, 331
The Practicing Manager: Profiting from Foreign Exchange Forecasts, 332
Summary, 333
Key Terms, 333
Questions, 333
Quantitative Problems, 334
Web Exercises: The Foreign Exchange Market, 335
Chapter 14. The International Financial System, 337
Preview, 337
Intervention in the Foreign Exchange Market, 337
Foreign Exchange Intervention and the Money Supply, 338
Inside the Fed: A Day at the Federal Reserve Bank of New York’s Foreign Exchange Desk, 339
Unsterilized Intervention, 340
Sterilized Intervention, 341
Balance of Payments, 342
Exchange Rate Regimes in the International Financial System, 343
Global: Why the Large U.S. Current Account Deficit Worries Economists, 344
Fixed Exchange Rate Regimes, 344
How a Fixed Exchange Rate Regime Works, 345
Global: The Euro’s Challenge to the Dollar, 345
Global: Argentina’s Currency Board, 348
Global: Dollarization, 349
Case: The Foreign Exchange Crisis of September 1992, 349
The Practicing Manager: Profiting from a Foreign Exchange Crisis, 351
Case: Recent Foreign Exchange Crises in Emerging Market Countries: Mexico 1994, East Asia 1997, Brazil 1999, and Argentina 2002, 352
Case: How Did China Accumulate Over $1 Trillion of International Reserves?, 353
Managed Float, 354
Capital Controls, 355
Controls on Capital Outflows, 355
Controls on Capital Inflows, 355
The Role of the IMF, 356
Should the IMF Be an International Lender of Last Resort?, 356
How Should the IMF Operate?, 358
Summary, 359
Key Terms, 359
Questions, 360
Quantitative Problems, 361
Web Exercises: The International Financial System, 361
Part Five. Fundamentals of Financial Institutions, 363
Chapter 15. Why Do Financial Institutions Exist?, 365
Preview, 365
Basic Facts About Financial Structure Throughout the World, 365
Transaction Costs, 369
How Transaction Costs Influence Financial Structure, 369
How Financial Intermediaries Reduce Transaction Costs, 369
Asymmetric Information: Adverse Selection and Moral Hazard, 370
The Lemons Problem: How Adverse Selection Influences Financial Structure, 371
Lemons in the Stock and Bond Markets, 371
Tools to Help Solve Adverse Selection Problems, 372
Conflicts of Interest: The Enron Implosion, 374
How Moral Hazard Affects the Choice Between Debt and Equity Contracts, 376
Moral Hazard in Equity Contracts: The Principal–Agent Problem, 377
Tools to Help Solve the Principal–Agent Problem, 378
How Moral Hazard Influences Financial Structure in Debt Markets, 379
Tools to Help Solve Moral Hazard in Debt Contracts, 380
Summary, 382
Case: Financial Development and Economic Growth, 383
Case: Is China a Counter-Example to the Importance of Financial Development?, 385
Financial Crises and Aggregate Economic Activity, 386
Factors Causing Financial Crises, 386
Case: Financial Crises in the United States, 389
Mini-Case: Case Study of a Financial Crisis: The Great Depression, 391
Case: Financial Crises in Emerging Market Countries: Mexico, 1994–1995; East Asia, 1997–1998; and Argentina, 2001–2002, 391
Summary, 395
Key Terms, 396
Questions, 396
Quantitative Problems, 397
Web Exercises: Why Do Financial Institutions Exist?, 397
Chapter 16. What Should Be Done About Conflicts of Interest? A Central Issue in Business Ethics, 399
Preview, 399
What Are Conflicts of Interest and Why Are They Important?, 400
Why Do We Care About Conflicts of Interest?, 401
Ethics and Conflicts of Interest, 401
Types of Conflicts of Interest, 401
Underwriting and Research in Investment Banking, 401
Auditing and Consulting in Accounting Firms, 402
Conflicts of Interest: The King, Queen, and Jack of the Internet, 403
Conflicts of Interest: Frank Quattrone and Spinning, 404
Credit Assessment and Consulting in Credit-Rating Agencies, 404
Conflicts of Interest: The Collapse of Arthur Andersen, 405
Universal Banking, 405
Mini-Case: Why Do Issuers of Securities Pay to Have Their Securities Rated?, 406
Can the Market Limit Exploitation of Conflicts of Interest?, 406
Conflicts of Interest: Banksters, 407
What Has Been Done to Remedy Conflicts of Interest?, 410
Sarbanes-Oxley Act of 2002, 410
Global Legal Settlement of 2002, 410
A Framework for Evaluating Policies to Remedy Conflicts of Interest, 411
Approaches to Remedying Conflicts of Interest, 412
Case: Evaluating Sarbanes-Oxley and the Global Legal Settlement, 414
Summary, 417
Key Terms, 417
Questions, 417
Web Exercises: What Should Be Done About Conflicts of Interest?, 418
Part Six. The Financial Institutions Industry, 419
Chapter 17. Banking and the Management of Financial Institutions, 421
Preview, 421
The Bank Balance Sheet, 421
Liabilities, 422
Assets, 424
Basic Banking, 425
General Principles of Bank Management, 428
Liquidity Management and the Role of Reserves, 428
Asset Management, 431
Liability Management, 432
Capital Adequacy Management, 433
The Practicing Manager: Strategies for Managing Bank Capital, 435
Case: Did the Capital Crunch Cause a Credit Crunch in the Early 1990s?, 436
Off-Balance-Sheet Activities, 437
Loan Sales, 437
Generation of Fee Income, 437
Trading Activities and Risk Management Techniques, 438
Conflicts of Interest: Barings, Daiwa, Sumitomo, and Allied Irish: Rogue Traders and the Principal–Agent Problem, 439
Measuring Bank Performance, 440
Bank’s Income Statement, 440
Measures of Bank Performance, 442
Recent Trends in Bank Performance Measures, 443
Summary, 444
Key Terms, 445
Questions, 445
Quantitative Problems, 446
Web Exercises: Banking and the Management of Financial Institutions, 447
Chapter 18. Commercial Banking Industry: Structure and Competition, 449
Preview, 449
Historical Development of the Banking System, 450
Multiple Regulatory Agencies, 452
Financial Innovation and the Evolution of the Banking Industry, 452
Responses to Changes in Demand Conditions: Interest Rate Volatility, 453
Responses to Changes in Supply Conditions: Information Technology, 454
E-Finance: Will “Clicks” Dominate “Bricks” in the Banking Industry?, 456
E-Finance: Why Are Scandinavians So Far Ahead of Americans in Using Electronic Payments and Online Banking?, 457
E-Finance: Are We Headed for a Cashless Society?, 458
Avoidance of Existing Regulations, 460
The Practicing Manager: Profiting from a New Financial Product: A Case Study of Treasury Strips, 462
Financial Innovation and the Decline of Traditional Banking, 464
Structure of the U.S. Commercial Banking Industry, 467
Restrictions on Branching, 468
Response to Branching Restrictions, 469
Bank Consolidation and Nationwide Banking, 470
E-Finance: Information Technology and Bank Consolidation, 472
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, 472
What Will the Structure of the U.S. Banking Industry Look Like in the Future?, 473
Are Bank Consolidation and Nationwide Banking Good Things?, 473
Separation of Banking and Other Financial Service Industries, 474
Erosion of Glass-Steagall, 474
The Gramm-Leach-Bliley Financial Services Modernization Act of 1999: Repeal of Glass-Steagall, 475
Implications for Financial Consolidation, 475
Separation of the Banking and Other Financial Services Industries Throughout the World, 475
International Banking, 476
Eurodollar Market, 477
Structure of U.S. Banking Overseas, 477
Foreign Banks in the United States, 478
Summary, 479
Key Terms, 480
Questions, 480
Web Exercises: Commercial Banking Industry: Structure and Competition, 481
Chapter 19. Savings Associations and Credit Unions, 483
Preview, 483
Mutual Savings Banks, 484
Savings and Loan Associations, 485
Mutual Savings Banks and Savings and Loans Compared, 485
Savings and Loans in Trouble: The Thrift Crisis, 486
Later Stages of the Crisis: Regulatory Forbearance, 487
Competitive Equality in Banking Act of 1987, 488
Political Economy of the Savings and Loan Crisis, 489
Principal-Agent Problem for Regulators and Politicians, 489
Case: Principal-Agent Problem in Action: Charles Keating and the Lincoln Savings and Loan Scandal, 490
Savings and Loan Bailout: Financial Institutions Reform, Recovery, and Enforcement Act of 1989, 491
The Savings and Loan Industry Today, 492
Number of Institutions, 493
S&L Size, 493
S&L Assets, 494
S&L Liabilities and Net Worth, 496
Capital, 496
Profitability and Health, 496
The Future of the Savings and Loan Industry, 497
Credit Unions, 499
History and Organization, 499
Sources of Funds, 504
Uses of Funds, 505
Advantages and Disadvantages of Credit Unions, 505
The Future of Credit Unions, 506
Summary, 507
Key Terms, 508
Questions, 508
Web Exercises: Savings Associations and Credit Unions, 509
Chapter 20. Banking Regulation, 511
Preview, 511
Asymmetric Information and Bank Regulation, 511
Government Safety Net: Deposit Insurance and the FDIC, 512
Global: The Spread of Government Deposit Insurance Throughout the World: Is This a Good Thing?, 514
Restrictions on Asset Holdings and Bank Capital Requirements, 515
Global: Basel 2: How Well Will It Work?, 517
Bank Supervision: Chartering and Examination, 518
Assessment of Risk Management, 519
Disclosure Requirements, 520
Consumer Protection, 520
Restrictions on Competition, 520
E-Finance: Electronic Banking: New Challenges for Bank Regulation, 521
International Banking Regulation, 523
Problems in Regulating International Banking, 523
Summary, 524
The 1980s U.S. Banking Crisis, 524
Federal Deposit Insurance Corporation Improvement Act of 1991, 526
Banking Crises Throughout the World, 527
Scandinavia, 528
Latin America, 529
Russia and Eastern Europe, 530
Japan, 531
China, 532
East Asia, 532
“Déjà Vu All Over Again”, 533
Summary, 533
Key Terms, 534
Questions, 534
Quantitative Problems, 534
Web Exercises: Banking Regulation, 535
Chapter 21. The Mutual Fund Industry, 537
Preview, 537
The Growth of Mutual Funds, 537
The First Mutual Funds, 538
Benefits of Mutual Funds, 538
Ownership of Mutual Funds, 539
Mutual Fund Structure, 542
Open- Versus Closed-End Funds, 542
Organizational Structure, 542
Case: Calculating a Mutual Fund’s Net Asset Value, 543
Investment Objective Classes, 544
Equity Funds, 544
Bond Funds, 545
Hybrid Funds, 546
Money Market Funds, 546
Index Funds, 548
Fee Structure of Investment Funds, 549
Regulation of Mutual Funds, 550
Hedge Funds, 551
Mini-Case: The Long Term Capital Debacle, 553
Conflicts of Interest in the Mutual Fund Industry, 554
Sources of Conflicts of Interest, 554
Conflicts of Interest: Many Mutual Funds Are Caught Ignoring Ethical Standards, 555
Mutual Fund Abuses, 555
Conflicts of Interest: SEC Survey Reports Mutual Fund Abuses Widespread, 557
Government Response to Abuses, 557
Summary, 558
Key Terms, 558
Questions, 559
Quantitative Problems, 559
Web Exercises: Investment Banks, Brokerage Firms, and Mutual Funds, 560
Chapter 22. Insurance Companies and Pension Funds, 561
Preview, 561
Insurance Companies, 562
Fundamentals of Insurance, 563
Adverse Selection and Moral Hazard in Insurance, 563
Selling Insurance, 564
Mini-Case: Insurance Agent: The Customer’s Ally, 565
Growth and Organization of Insurance Companies, 565
Types of Insurance, 566
Life Insurance, 567
Health Insurance, 570
Property and Casualty Insurance, 572
Insurance Regulation, 574
Conflicts of Interest: Insurance Behemoth Charged with Conflicts of Interest Violations, 574
The Practicing Manager: Insurance Management, 575
Screening, 575
Risk-Based Premium, 576
Restrictive Provisions, 576
Prevention of Fraud, 577
Cancellation of Insurance, 577
Deductibles, 577
Coinsurance, 577
Limits on the Amount of Insurance, 577
Summary, 578
Pensions, 578
Types of Pensions, 578
Defined-Benefit Pension Plans, 579
Defined-Contribution Pension Plans, 579
Private and Public Pension Plans, 580
Mini-Case: Power to the Pensions, 581
Regulation of Pension Plans, 584
Employee Retirement Income Security Act, 584
Individual Retirement Plans, 587
The Future of Pension Funds, 587
Summary, 587
Key Terms, 588
Questions, 588
Quantitative Problems, 589
Web Exercises: Insurance Companies and Pension Funds, 589
Chapter 23. Investment Banks, Security Brokers and Dealers, and Venture Capital Firms, 591
Preview, 591
Investment Banks, 592
Background, 592
Underwriting Stocks and Bonds, 593
Following the Financial News: New Securities Issues, 596
Equity Sales, 598
Mergers and Acquisitions, 599
Securities Brokers and Dealers, 600
Brokerage Services, 600
Mini-Case: Example of Using the Limit-Order Book, 603
Securities Dealers, 604
Regulation of Securities Firms, 604
Relationship Between Securities Firms and Commercial Banks, 605
Private Equity Investment, 606
Venture Capital Firms, 606
Private Equity Buyouts, 610
E-Finance: Venture Capitalists Lose Focus with Internet Companies, 611
Advantages to Private Equity Buyouts, 611
Life Cycle of the Private Equity Buyout, 612
Implications of the Private Equity Ownership Structure, 612
Summary, 613
Key Terms, 613
Questions, 614
Quantitative Problems, 614
Web Exercises: Investment Banks, Security Brokers and Dealers, and Venture Capital Firms, 615
Part Seven. The Management of Financial Institutions, 617
Chapter 24. Risk Management in Financial Institutions, 619
Preview, 619
Managing Credit Risk, 619
Screening and Monitoring, 620
Long-Term Customer Relationships, 621
Loan Commitments, 622
Collateral, 622
Compensating Balances, 622
Credit Rationing, 623
Managing Interest-Rate Risk, 624
Income Gap Analysis, 625
Duration Gap Analysis, 627
Example of a Nonbanking Financial Institution, 631
Some Problems with Income Gap and Duration Gap Analyses, 633
The Practicing Manager: Strategies for Managing Interest-Rate Risk, 634
Summary, 636
Key Terms, 636
Questions, 636
Quantitative Problems, 637
Web Exercises: Risk Management in Financial Institutions, 639
Chapter 25. Hedging with Financial Derivatives, 641
Preview, 641
Hedging, 641
Forward Markets, 642
Interest-Rate Forward Contracts, 642
The Practicing Manager: Hedging Interest-Rate Risk with Forward Contracts, 642
Pros and Cons of Forward Contracts, 643
Financial Futures Markets, 644
Financial Futures Contracts, 644
Following the Financial News: Financial Futures, 645
The Practicing Manager: Hedging with Financial Futures, 646
Organization of Trading in Financial Futures Markets, 648
Globalization of Financial Futures Markets, 648
Explaining the Success of Futures Markets, 649
Mini-Case: The Hunt Brothers and the Silver Crash, 651
The Practicing Manager: Hedging Foreign Exchange Risk with Forward and Futures Contracts, 652
Hedging Foreign Exchange Risk with Forward Contracts, 652
Hedging Foreign Exchange Risk with Futures Contracts, 653
Stock Index Futures, 654
Stock Index Futures Contracts, 654
Mini-Case: Program Trading and Portfolio Insurance: Were They to Blame for the Stock Market Crash of 1987?, 654
Following the Financial News: Stock Index Futures, 655
The Practicing Manager: Hedging with Stock Index Futures, 656
Options, 657
Options Contracts, 657
Profits and Losses on Option and Futures Contracts, 658
Factors Affecting the Prices of Option Premiums, 661
Summary, 662
The Practicing Manager: Hedging with Futures Options, 663
Interest-Rate Swaps, 664
Interest-Rate Swap Contracts, 664
The Practicing Manager: Hedging with Interest-Rate Swaps, 665
Advantages of Interest-Rate Swaps, 666
Disadvantages of Interest-Rate Swaps, 666
Financial Intermediaries in Interest-Rate Swaps, 667
Credit Derivatives, 667
Credit Options, 668
Credit Swaps, 668
Credit-Linked Notes, 669
Case: Are Financial Derivatives a Worldwide Time Bomb?, 669
Conflicts of Interest: The Orange County Bankruptcy, 670
Summary, 671
Key Terms, 672
Questions, 672
Quantitative Problems, 673
Web Exercises: Hedging with Financial Derivatives, 675
Glossary, G-1
Index, I-1
Bridging the Gap: Applying Theory to Practice, EP-1

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