Financial Markets and Institutions, 13th Edition PDF by Jeff Madura


Financial Markets & Institutions, 13th Edition

By Jeff Madura

Financial Markets & Institutions


Preface, xxiii

About the Author, xxix

Part 1: Overview of the Financial Environment

1: Role OF Financial Markets And Institutions

1-1 Role of Financial Markets, 3

1-1a Accommodating Corporate Finance Needs, 4

1-1b Accommodating Investment Needs, 4

1-2 Securities Traded in Financial Markets, 5

1-2a Money Market Securities, 5

1-2b Capital Market Securities, 5

1-2c Derivative Securities, 7

1-2d Valuation of Securities, 8

1-2e Securities Regulations on Financial Disclosure, 10

1-2f International Financial Markets, 11

1-3 Role of Financial Institutions, 12

1-3a Role of Depository Institutions, 12

1-3b Role of Nondepository Financial Institutions, 13

1-3c Comparison of Roles among Financial Institutions, 15

1-3d Relative Importance of Financial Institutions, 16

1-3e Consolidation of Financial Institutions, 17

1-4 Systemic Risk among Financial Institutions, 18

2: Determination OF Interest Rates

2-1 Loanable Funds Theory, 25

2-1a Household Demand for Loanable Funds, 26

2-1b Business Demand for Loanable Funds, 26

2-1c Government Demand for Loanable Funds, 26

2-1d Foreign Demand for Loanable Funds, 28

2-1e Aggregate Demand for Loanable Funds, 28

2-1f Supply of Loanable Funds, 28

2-1g Equilibrium Interest Rate, 30

2-2 Factors That Affect Interest Rates, 32

2-2a Impact of Economic Growth on Interest Rates, 32

2-2b Impact of Inflation on Interest Rates, 33

2-2c Impact of Monetary Policy on Interest Rates, 35

2-2d Impact of the Budget Deficit on Interest Rates, 35

2-2e Impact of Foreign Flows of Funds on Interest Rates, 37

2-3 Forecasting Interest Rates, 38

3: Structure OF Interest Rates

3-1 Why Debt Security Yields Vary, 45

3-1a Credit (Default) Risk, 45

3-1b Liquidity, 47

3-1c Tax Status, 48

3-1d Term to Maturity, 49

3-2 Modeling the Yield to be Offered on a Debt Security, 49

3-3 A Closer Look at the Term Structure, 50

3-3a Pure Expectations Theory, 50

3-3b Liquidity Premium Theory, 55

3-3c Segmented Markets Theory, 57

3-3d Integrating the Term Structure Theories, 58

3-3e Use of the Term Structure, 59

3-3f How the Yield Curve Has Changed over Time, 60

3-3g International Structure of Interest Rates, 61

Part 1 integrative Problem: interest rate Forecasts and investment Decisions, 67

Part 2: the Fed and Monetary Policy

4: Functions OF The FED

4-1 Organizational Structure of the Fed, 71

4-1a Federal Reserve District Banks, 71

4-1b Member Banks, 72

4-1c Board of Governors, 73

4-1d Federal Open Market Committee, 73

4-1e Advisory Committees, 73

4-1f Integration of Federal Reserve Components, 74

4-1g Consumer Financial Protection Bureau, 74

4-2 Fed Control of the Money Supply, 74

4-2a Decision Process, 75

4-2b Role of the Fed’s Trading Desk, 77

4-2c Control of M1 versus M2, 79

4-2d How Open Market Operations Affect All Interest Rates, 79

4-2e Alternative Monetary Policy Tools, 80

4-3 The Fed’s Intervention during the Credit Crisis, 81

4-3a Fed Loans to Facilitate the Rescue of Bear Stearns, 81

4-3b The Fed’s Strategy of Quantitative Easing, 81

4-3c Perceptions of the Fed’s Intervention during the Crisis, 83

4-4 Global Monetary Policy, 83

4-4a A Single Eurozone Monetary Policy, 83

5: Monetary Policy

5-1 Input Used to Determine Monetary Policy, 89

5-1a Indicators of Economic Growth, 89

5-1b Indicators of Inflation, 90

5-2 Implementing a Stimulative Monetary Policy, 92

5-2a How a Stimulative Monetary Policy Reduces Interest Rates, 92

5-2b How Lower Interest Rates Increase Business Investment, 93

5-2c How Lower Interest Rates Lower the Business Cost of Equity, 94

5-2d Summary of Stimulative Monetary Policy Effects, 94

5-2e Why a Stimulative Monetary Policy Might Fail, 95

5-3 Implementing a Restrictive Monetary Policy, 98

5-3a Comparing a Restrictive versus Stimulative Monetary Policy, 99

5-4 Trade-off in Monetary Policy, 100

5-4a Impact of Other Forces on the Trade-off, 100

5-4b How Monetary Policy Responds to Fiscal Policy, 102

5-4c Proposals to Focus on Inflation, 102

5-5 Monitoring the Impact of Monetary Policy, 104

5-5a Impact on Financial Markets, 104

5-6 Global Monetary Policy, 106

5-6a Impact of the Dollar, 106

5-6b Impact of Global Economic Conditions, 107

5-6c Transmission of Interest Rates, 107

Part 2 integrative Problem: Fed Watching, 113

Part 3: Debt Security Markets

6: Money Markets

6-1 Money Market Securities, 117

6-1a Treasury Bills, 118

6-1b Treasury Bill Auction, 120

6-1c Commercial Paper, 121

6-1d Negotiable Certificates of Deposit, 125

6-1e Repurchase Agreements, 126

6-1f Federal Funds, 127

6-1g Banker’s Acceptances, 128

6-1h Summary of Money Market Securities, 130

6-2 Institutional Use of Money Markets, 131

6-3 Globalization of Money Markets, 132

6-3a International Interbank Market, 132

6-3b Eurodollar Securities, 133

6-3c Performance of Foreign Money Market Securities, 134

7: BOND Markets

7-1 Background on Bonds, 141

7-1a Institutional Participation in Bond Markets, 142

7-1b Bond Yields, 143

7-2 Treasury and Federal Agency Bonds, 144

7-2a Treasury Bond Auctions, 144

7-2b Trading Treasury Bonds, 145

7-2c Stripped Treasury Bonds, 145

7-2d Inflation-Indexed Treasury Bonds, 146

7-2e Savings Bonds, 146

7-2f Federal Agency Bonds, 147

7-3 Municipal Bonds, 147

7-3a Credit Risk of Municipal Bonds, 148

7-3b Variable-Rate Municipal Bonds, 149

7-3c Tax Advantages of Municipal Bonds, 149

7-3d Trading and Quotations of Municipal Bonds, 149

7-3e Yields Offered on Municipal Bonds, 150

7-4 Corporate Bonds, 150

7-4a Corporate Bond Offerings, 150

7-4b Secondary Market for Corporate Bonds, 153

7-4c Characteristics of Corporate Bonds, 154

7-4d How Corporate Bonds Finance Restructuring, 156

7-4e Collateralized Debt Obligations, 157

7-5 Globalization of Bond and Loan Markets, 158

7-5a Global Government Debt Markets, 158

7-6 Other Types of Long-term Debt Securities, 159

7-6a Structured Notes, 159

7-6b Exchange-Traded Notes, 160

7-6c Auction-Rate Securities, 160

8: BOND Valuation And Risk

8-1 Bond Valuation Process, 165

8-1a Impact of the Discount Rate on Bond Valuation, 166

8-1b Impact of the Timing of Payments on Bond Valuation, 166

8-1c Valuation of Bonds with Semiannual Payments, 167

8-1d Relationships among Coupon Rate, Required Return, and Bond Price,

8-2 Explaining Bond Price Movements, 170

8-2a Factors That Affect the Risk-Free Rate, 170

8-2b Factors That Affect the Credit (Default) Risk Premium, 172

8-2c Summary of Factors Affecting Bond Prices, 173

8-2d Implications for Financial Institutions, 174

8-3 Sensitivity of Bond Prices to Interest Rate Movements, 175

8-3a Bond Price Elasticity, 175

8-3b Duration, 177

8-4 Bond Investment Strategies, 180

8-4a Matching Strategy, 180

8-4b Laddered Strategy, 181

8-4c Barbell Strategy, 181

8-4d Interest Rate Strategy, 181

8-5 Valuation and Risk of International Bonds, 181

8-5a Influence of Foreign Interest Rate Movements, 182

8-5b Influence of Credit Risk, 182

8-5c Influence of Exchange Rate Fluctuations, 182

8-5d International Bond Diversification, 183

appendix 8: Forecasting Bond Prices and yields, 191

9: Mortgage Markets

9-1 Background on Mortgages, 193

9-1a How Mortgage Markets Facilitate the Flow of Funds, 193

9-1b Criteria Used to Measure Creditworthiness, 195

9-1c Classifications of Mortgages, 195

9-2 Types of Residential Mortgages, 196

9-2a Fixed-Rate Mortgages, 196

9-2b Adjustable-Rate Mortgages, 197

9-2c Graduated-Payment Mortgages, 199

9-2d Growing-Equity Mortgages, 199

9-2e Second Mortgages, 199

9-2f Shared-Appreciation Mortgages, 199

9-2g Balloon-Payment Mortgages, 199

9-3 Valuation of Mortgages, 200

9-3a Credit Risk, 200

9-3b Interest Rate Risk, 201

9-3c Prepayment Risk, 202

9-4 Mortgage-Backed Securities, 202

9-4a The Securitization Process, 202

9-4b Types of Mortgage-Backed Securities, 203

9-4c Valuation of Mortgage-Backed Securities, 205

9-5 Credit Crisis, 205

9-5a Impact of the Credit Crisis on Fannie Mae and Freddie Mac, 206

9-5b Impact of the Credit Crisis on Exposed Financial Institutions, 207

9-5c Systemic Risk Due to the Credit Crisis, 208

9-5d Who Is to Blame for the Credit Crisis?, 209

9-5e Government Programs Implemented in Response to the Crisis, 211

9-5f Financial Reform Act of 2010, 212

Part 3 integrative Problem: asset allocation, 217

Part 4: Equity Markets

10: Stock Offerings And Investor Monitoring

10-1 Private Equity, 221

10-1a Financing by Venture Capital Funds, 221

10-1b Financing by Private Equity Funds, 223

10-1c Financing by Crowdfunding, 224

10-2 Public Equity, 225

10-2a Ownership and Voting Rights, 225

10-2b How Stock Markets Facilitate Corporate Financing, 226

10-2c Participation of Financial Institutions in Stock Markets, 226

10-2d Secondary Market for Stocks, 228

10-3 Initial Public Offerings, 228

10-3a Process of Going Public, 228

10-3b Underwriter Efforts to Ensure Price Stability, 231

10-3c Facebook’s IPO, 232

10-3d Abuses in the IPO Market, 232

10-3e Long-Term Performance Following IPOs, 233

10-4 Stock Offerings and Repurchases, 234

10-4a Secondary Stock Offerings, 234

10-4b Stock Repurchases, 235

10-5 Stock Exchanges, 235

10-5a Organized Exchanges, 235

10-5b Over-the-Counter Market, 236

10-5c Extended Trading Sessions, 236

10-5d Stock Quotations Provided by Exchanges, 237

10-5e Stock Index Quotations, 238

10-5f Private Stock Exchanges, 239

10-6 Monitoring Publicly Traded Companies, 240

10-6a Role of Analysts, 240

10-6b Sarbanes-Oxley Act, 240

10-6c Shareholder Activism, 241

10-6d Limited Power of Governance, 243

10-7 Market for Corporate Control, 243

10-7a Use of LBOs to Achieve Corporate Control, 243

10-7b Barriers to the Market for Corporate Control, 244

10-8 Globalization of Stock Markets, 245

10-8a Privatization, 245

10-8b Emerging Stock Markets, 245

10-8c Variation in Characteristics across Stock Markets, 245

10-8d Methods Used to Invest in Foreign Stocks, 246

11: Stock Valuation And Risk

11-1 Stock Valuation Methods, 253

11-1a Price–Earnings Method, 253

11-1b Dividend Discount Model, 255

11-1c Adjusted Dividend Discount Model, 256

11-1d Free Cash Flow Model, 257

11-2 Required Rate of Return on Stocks, 257

11-2a Capital Asset Pricing Model, 257

11-3 Factors That Affect Stock Prices, 259

11-3a Economic Factors, 259

11-3b Market-Related Factors, 261

11-3c Firm-Specific Factors, 261

11-3d Tax Effects, 261

11-3e Integration of Factors Affecting Stock Prices, 262

11-3f Gaining an Edge in the Valuation Process, 263

11-4 Stock Risk, 264

11-4a Volatility of a Stock, 265

11-4b Beta of a Stock, 267

11-4c Value at Risk, 269

11-5 Measuring Risk-Adjusted Stock Performance, 270

11-5a Sharpe Index, 271

11-5b Treynor Index, 271

11-6 Stock Market Efficiency 272

11-6a Forms of Stock Market Efficiency, 272

11-6b Tests of the Efficient Market Hypothesis, 273

11-7 Foreign Stock Valuation and Performance 274

11-7a Valuation of Foreign Stocks, 274

11-7b International Market Efficiency, 274

11-7c Measuring Performance from Investing in Foreign Stocks, 275

11-7d Performance from Global Diversification, 275

appendix 11: the link between accounting and Stock Valuation, 282

12: Market Microstructure And Strategies

12-1 Stock Market Transactions, 291

12-1a Placing an Order, 291

12-1b Margin Trading, 292

12-1c Short Selling, 294

12-2 How Stock Transactions are Executed, 297

12-2a Floor Brokers, 297

12-2b Market Makers, 297

12-2c The Spread on Stock Transactions, 298

12-2d Electronic Communication Networks, 299

12-3 High Frequency Trading, 301

12-3a Program Trading, 301

12-3b Bots and Algorithms, 302

12-3c Impact of High Frequency Trading on Stock Volatility, 303

12-3d High Frequency Insider Trading, 305

12-3e High Frequency Front Running, 305

12-3f Impact of High Frequency Trading on Spreads, 307

12-4 Regulation of Stock Trading, 308

12-4a Circuit Breakers, 308

12-4b Trading Halts, 308

12-4c Taxes Imposed on Stock Transactions, 309

12-4d Securities and Exchange Commission, 309

12-5 Trading International Stocks, 311

12-5a Reduction in Transaction Costs, 311

12-5b Reduction in Information Costs, 311

Part 4 integrative Problem: Stock Market analysis, 315

Part 5: Derivative Security Markets

13: Financial Futures Markets

13-1 Background on Financial Futures, 319

13-1a Popular Futures Contracts, 319

13-1b Markets for Financial Futures, 319

13-1c Purpose of Trading Financial Futures, 320

13-1d Institutional Trading of Futures Contracts, 320

13-1e Trading Process, 321

13-2 Interest Rate Futures Contracts, 322

13-2a Valuing Interest Rate Futures, 322

13-2b Speculating in Interest Rate Futures, 324

13-2c Hedging with Interest Rate Futures, 326

13-3 Stock Index Futures, 329

13-3a Valuing Stock Index Futures, 329

13-3b Speculating in Stock Index Futures, 330

13-3c Hedging with Stock Index Futures, 331

13-3d Dynamic Asset Allocation with Stock Index Futures, 332

13-3e Arbitrage with Stock Index Futures, 332

13-3f Circuit Breakers on Stock Index Futures, 333

13-4 Single Stock Futures, 333

13-5 Risk of Trading Futures Contracts, 334

13-5a Market Risk, 334

13-5b Basis Risk, 334

13-5c Liquidity Risk, 334

13-5d Credit Risk, 334

13-5e Prepayment Risk, 335

13-5f Operational Risk, 335

13-5g Systemic Risk, 335

13-6 Globalization of Futures Markets, 336

13-6a Non-U.S. Participation in U.S. Futures Contracts, 336

13-6b Foreign Stock Index Futures, 336

13-6c Currency Futures Contracts, 336

14: Option Markets

14-1 Background on Options, 343

14-1a Comparison of Options and Futures, 343

14-1b Markets Used to Trade Options, 344

14-1c Types of Orders, 345

14-1d Stock Option Quotations, 345

14-1e Institutional Use of Options, 346

14-2 Determinants of Stock Option Premiums, 346

14-2a Determinants of Call Option Premiums, 346

14-2b Determinants of Put Option Premiums, 348

14-2c How Option Pricing Can Be Used to Derive a Stock’s Volatility, 349

14-2d Explaining Changes in Option Premiums, 349

14-3 Speculating with Stock Options, 350

14-3a Speculating with Call Options, 351

14–3b Speculating with Put Options, 352

14-3c Excessive Risk from Speculation, 354

14-4 Hedging with Stock Options, 355

14-4a Hedging with Covered Call Options, 355

14-4b Hedging with Put Options, 356

14-5 Options on ETFs and Stock Indexes, 357

14-5a Hedging with Stock Index Options, 357

14-5b Using Index Options to Measure the Market’s Risk, 359

14-6 Options on Futures Contracts, 359

14-6a Speculating with Options on Futures, 360

14-6b Hedging with Options on Interest Rate Futures, 361

14-6c Hedging with Options on Stock Index Futures, 362

14-7 Options as Executive Compensation, 362

14-8 Globalization of Options Markets, 363

14-8a Currency Options Contracts, 363

appendix 14: Option Valuation, 370

15: Swap Markets

15-1 Background, 379

15-1a Use of Swaps for Hedging, 380

15-1b Use of Swaps to Accommodate Financing, 381

15-1c Use of Swaps for Speculating, 382

15-1d Participation by Financial Institutions, 382

15-2 Types of Swaps, 383

15-2a Plain Vanilla Swaps, 383

15-2b Forward Swaps, 385

15-2c Callable Swaps, 386

15-2d Putable Swaps, 386

15-2e Extendable Swaps, 387

15-2f Zero-Coupon-for-Floating Swaps, 388

15-2g Rate-Capped Swaps, 388

15-2h Equity Swaps, 389

15-2i Tax Advantage Swaps, 389

15-3 Risks of Interest Rate Swaps, 390

15-3a Basis Risk, 390

15-3b Credit Risk, 390

15-3c Sovereign Risk, 391

15-4 Pricing Interest Rate Swaps, 391

15-4a Prevailing Market Interest Rates, 391

15-4b Availability of Counterparties, 391

15-4c Credit and Sovereign Risk, 391

15-5 Performance of Interest Rate Swaps, 391

15-6 Interest Rate Caps, Floors, and Collars, 393

15-6a Interest Rate Caps, 393

15-6b Interest Rate Floors, 394

15-6c Interest Rate Collars, 395

15-7 Credit Default Swaps, 396

15-7a Secondary Market for CDS Contracts, 396

15-7b Collateral on CDS Contracts, 397

15-7c Payments on a Credit Default Swap, 397

15-7d How CDS Contracts Affect Debtor–Creditor Negotiations, 397

15-7e Impact of the Credit Crisis on the CDS Market, 397

15-7f Reform of CDS Contracts, 399

15-8 Globalization of Swap Markets, 400

15-8a Currency Swaps, 400

16: Foreign Exchange Derivative Markets

16-1 Foreign Exchange Markets and Systems, 407

16-1a Spot Market, 407

16-1b Forward Market, 408

16-1c Institutional Use of Foreign Exchange Markets, 408

16-1d Types of Exchange Rate Systems, 409

16-1e Eurozone Arrangement, 410

16-1f Cryptocurrencies, 411

16-2 Factors Affecting Exchange Rates, 414

16-2a Differential Inflation Rates, 414

16-2b Differential Interest Rates, 415

16-2c Central Bank Intervention, 415

16-3 Forecasting Exchange Rates, 416

16-3a Technical Forecasting, 416

16-3b Fundamental Forecasting, 417

16-3c Market-Based Forecasting, 417

16-3d Mixed Forecasting, 417

16-4 Foreign Exchange Derivatives, 417

16-4a Forward Contracts, 418

16-4b Currency Futures Contracts, 418

16-4c Currency Swaps, 419

16-4d Currency Options Contracts, 419

16-4e Comparing Foreign Exchange Derivatives for Hedging, 419

16-4f Comparing Foreign Exchange Derivatives for Speculating, 419

16-5 International Arbitrage, 421

16-5a Locational Arbitrage, 421

16-5b Triangular Arbitrage, 422

16-5c Covered Interest Arbitrage, 422

appendix 16: Currency Option Pricing, 429

Part 5 integrative Problem: Choosing among Derivative Securities, 433

Midterm Self-Exam, 435

Part 6: Commercial Banking

17: Commercial Bank Operations

17-1 Background on Commercial Banks, 443

17-1a Bank Market Structure, 443

17-2 Banks’ Sources of Funds, 444

17-2a Transaction Deposits, 445

17-2b Savings Deposits, 446

17-2c Time Deposits, 446

17-2d Money Market Deposit Accounts, 446

17-2e Federal Funds Purchased, 447

17-2f Borrowing from the Federal Reserve Banks, 447

17-2g Repurchase Agreements, 448

17-2h Eurodollar Borrowings, 448

17-2i Bonds Issued by the Bank, 448

17-2j Bank Capital, 448

17-2k Distribution of Banks’ Sources of Funds, 449

17-3 Banks’ Uses of Funds, 450

17-3a Cash, 450

17-3b Bank Loans, 450

17-3c Investment in Securities, 454

17-3d Federal Funds Sold, 455

17-3e Repurchase Agreements, 455

17-3f Eurodollar Loans, 455

17-3g Fixed Assets, 455

17-3h Proprietary Trading, 455

17-3i Distribution of Banks’ Uses of Funds, 456

17-4 Off-Balance Sheet Activities, 458

17-4a Loan Commitments, 458

17-4b Standby Letters of Credit, 459

17-4c Forward Contracts on Currencies, 459

17-4d Interest Rate Swap Contracts, 459

17-4e Credit Default Swap Contracts, 459

17-5 International Banking, 460

17-5a International Expansion, 460

17-5b Impact of the Euro on Global Competition, 460

17-5c International Exposure, 460

18: Bank Regulation

18-1 Regulatory Structure, 466

18-1a Regulators, 466

18-1b Regulation of Bank Ownership, 466

18-2 Regulation of Bank Operations, 466

18-2a Regulation of Deposit Insurance, 466

18-2b Regulation of Deposits, 468

18-2c Regulation of Bank Loans, 468

18-2d Regulation of Bank Investment in Securities, 469

18-2e Regulation of Securities Services, 469

18-2f Regulation of Off-Balance Sheet Transactions, 470

18-2g Regulation of the Accounting Process, 471

18-3 Regulation of Capital, 472

18-3a How Banks Satisfy Capital Requirements, 472

18-3b Basel I Accord, 473

18-3c Basel II Framework, 473

18-3d Basel III Framework, 474

18-3e Use of the VaR Method to Determine Capital Levels, 474

18-3f Stress Tests Used to Determine Capital Levels, 475

18-4 How Regulators Monitor Banks, 475

18-4a CAMELS Ratings, 475

18-4b Corrective Action by Regulators, 477

18-4c Treatment of Failing Banks, 477

18-5 Government Actions during the Credit Crisis, 478

18-5a Government Rescue of Bear Stearns, 478

18-5b Failure of Lehman Brothers, 479

18-5c Government Rescue of AIG, 479

18-5d Argument for Government Rescue, 481

18-5e Argument against Government Rescue, 481

18-6 Government Funding during the Crisis, 482

18-6a Troubled Asset Relief Program (TARP), 482

18-6b Protests of Government Funding for Banks, 483

18-7 Financial Reform Act of 2010, 483

18-7a Mortgage Origination, 483

18-7b Sales of Mortgage-Backed Securities, 484

18-7c Financial Stability Oversight Council, 484

18-7d Orderly Liquidation, 484

18-7e Consumer Financial Protection Bureau, 484

18-7f Limits on Bank Proprietary Trading, 484

18-7g Trading of Derivative Securities, 485

18-7h Limitations of Regulatory Reform, 485

18-8 Global Bank Regulations, 486

18-8a Compliance with Basel III, 486

19: Bank Management

19-1 Bank Goals, Strategy, and Governance, 491

19-1a Aligning Managerial Compensation with Bank Goals, 491

19-1b Bank Strategy, 492

19-1c Bank Governance by the Board of Directors, 493

19-1d Other Forms of Bank Governance, 493

19-2 Managing Liquidity, 493

19-2a Management of Liabilities, 494

19-2b Management of Money Market Securities, 494

19-2c Management of Loans, 494

19-2d Use of Securitization to Boost Liquidity, 494

19-3 Managing Interest Rate Risk, 495

19-3a Methods Used to Assess Interest Rate Risk, 496

19-3b Whether to Hedge Interest Rate Risk, 501

19-3c Methods Used to Reduce Interest Rate Risk, 502

19-3d International Interest Rate Risk, 505

19-4 Managing Credit Risk, 506

19-4a Measuring Credit Risk, 506

19-4b Trade-Off between Credit Risk and Return, 506

19-4c Reducing Credit Risk, 507

19-5 Managing Market Risk, 508

19-5a Measuring Market Risk, 508

19-5b Methods Used to Reduce Market Risk, 509

19-6 Integrated Bank Management, 509

19-6a Application, 509

19-7 Managing Risk of International Operations, 513

19-7a Exchange Rate Risk, 513

19-7b Settlement Risk, 514

20: Bank Performance

20-1 Valuation of a Commercial Bank, 521

20-1a Factors That Affect Cash Flows, 521

20-1b Factors That Affect the Required Rate of Return by Investors, 523

20-1c Impact of the Credit Crisis on Bank Valuations, 524

20-2 Assessing Bank Performance, 525

20-2a Interest Income and Expenses, 525

20-2b Noninterest Income and Expenses, 526

20-2c Reliance on the Bank’s Financial Information, 527

20-3 Evaluation of a Bank’s ROA, 527

20-3a Reasons for a Low ROA, 528

20-3b Converting ROA to ROE, 529

20-3c Application, 530

Part 6 integrative Problem: Forecasting Bank Performance, 536

Part 7: Nonbank Operations

21: Thrift Operations

21-1 Background on Savings Institutions, 541

21-1a Ownership of Savings Institutions, 541

21-1b Regulation of Savings Institutions, 542

21-2 Sources and Uses of Funds, 543

21-2a Sources of Funds, 543

21-2b Uses of Funds, 543

21-2c Balance Sheet of Savings Institutions, 544

21-2d Interaction with Other Financial Institutions, 545

21-2e Participation in Financial Markets, 545

21-3 Valuation of a Savings Institution, 547

21-3a Factors That Affect Cash Flows, 547

21-3b Factors That Affect the Required Rate of Return, 548

21-4 Exposure to Risk, 548

21-4a Liquidity Risk, 548

21-4b Credit Risk, 549

21-4c Interest Rate Risk, 550

21-5 Management of Interest Rate Risk, 551

21-5a Adjustable-Rate Mortgages, 551

21-5b Interest Rate Futures Contracts, 552

21-5c Interest Rate Swaps, 552

21-5d Conclusions about Managing Interest Rate Risk, 552

21-6 Exposure of Savings Institutions to Crises, 553

21-6a Savings Institution Crisis in the Late 1980s, 553

21-6b Credit Crisis of 2008–2009, 554

21-6c Reform in Response to the Credit Crisis, 555

21-7 Credit Unions, 556

21-7a Ownership of Credit Unions, 556

21-7b Advantages and Disadvantages of Credit Unions, 556

21-7c Deposit Insurance for Credit Unions, 557

21-7d Regulatory Assessment of Credit Unions, 557

21-7e Credit Union Sources of Funds, 557

21-7f Credit Union Uses of Funds, 558

21-7g Exposure of Credit Unions to Risk, 558

22: Finance Company Operations

22-1 Types of Finance Companies, 563

22-1a Consumer Finance Companies, 563

22-1b Business Finance Companies, 563

22-1c Captive Finance Subsidiaries, 564

22-1d Regulation of Finance Companies, 564

22-2 Sources and Uses of Funds, 564

22-2a Sources of Funds, 565

22-2b Uses of Funds, 565

22-2c Interaction with Other Financial Institutions, 567

22-3 Valuation of a Finance Company, 568

22-3a Factors That Affect Cash Flows, 568

22-3b Factors That Affect the Required Rate of Return, 569

22-4 Exposure of Finance Companies to Risk, 570

22-4a Liquidity Risk, 570

22-4b Interest Rate Risk, 570

22-4c Credit Risk, 571

22-5 Multinational Finance Companies, 571

23: Mutual Fund Operations

23-1 Background on Mutual Funds, 575

23-1a Pricing Shares of a Mutual Fund, 576

23-1b Mutual Fund Distributions to Shareholders, 577

23-1c Regulation of Mutual Funds, 577

23-1d Management of Mutual Funds, 577

23-1e Expenses Incurred by Mutual Fund Shareholders, 579

23-1f Governance of Mutual Funds, 580

23-1g Mutual Fund Categories, 581

23-2 Stock and Bond Mutual Funds, 582

23-2a Types of Stock Mutual Funds, 582

23-2b Types of Bond Mutual Funds, 583

23-2c Hybrid Funds, 584

23-3 Money Market Funds, 585

23-3a Asset Composition of Money Market Funds, 585

23-3b Risk of Money Market Funds, 585

23-3c Management of Money Market Funds, 586

23-4 Hedge Funds, 587

23-4a Hedge Funds’ Use of Financial Leverage, 587

23-4b Hedge Fund Fees, 588

23-4c Hedge Funds’ Pursuit of Information, 588

23-4d Short Selling by Hedge Funds, 589

23-4e Madoff Fund Scandal, 590

23-4f Regulatory Reform of Hedge Funds, 590

23-5 Other Types of Funds, 590

23-5a Closed-End Funds, 591

23-5b Exchange-Traded Funds, 591

23-5c Venture Capital Funds, 593

23-5d Private Equity Funds, 593

23-5e Real Estate Investment Trusts, 594

23-6 Valuation and Performance of Mutual Funds, 595

23-6a Valuation of Stock Mutual Funds, 595

23-6b Valuation of Bond Mutual Funds, 596

23-6c Performance from Diversifying among Funds, 596

23-6d Ratings on Mutual Funds, 597

23-6e Research on Mutual Fund Performance, 597

24: SECuritiES OPEratiONS

24-1 Functions of Securities Firms, 603

24-1a Facilitating Stock Offerings, 603

24-1b Facilitating Bond Offerings, 605

24-1c Securitizing Mortgages, 607

24-1d Advising Corporations on Restructuring, 607

24-1e Financing for Corporations, 608

24-1f Providing Brokerage Services, 609

24-1g Operating Mutual Funds, 610

24-1h Proprietary Trading, 610

24-1i Summary of Services Provided, 611

24-1j Interaction with Other Financial Institutions, 612

24-1k Participation in Financial Markets, 612

24-1l Expanding Functions Internationally, 614

24-2 Regulation of Securities Firms, 614

24-2a Stock Exchange Regulations, 614

24-2b Regulations That Affect Securities Firms, 615

24-3 Valuation of a Securities Firm, 617

24-3a Factors That Affect Cash Flows, 617

24-3b Factors That Affect the Required Rate of Return, 618

24-4 Exposure of Securities Firms to Risk, 619

24-4a Market Risk, 619

24-4b Interest Rate Risk, 619

24-4c Credit Risk, 619

24-4d Exchange Rate Risk, 619

24-4e Counterparty Risk, 619

24-4f Impact of Financial Leverage on Exposure to Risk, 620

24-5 Impact of the Credit Crisis on Securities Firms, 621

24-5a Impact of the Crisis on Bear Stearns, 621

24-5b Impact of the Crisis on Merrill Lynch, 623

24-5c Impact of the Crisis on Lehman Brothers, 624

24-5d Impact of the Crisis on Regulatory Reform, 625

25-1 Setting Insurance Premiums, 631

25-1a Adverse Selection Problem, 632

25-1b Moral Hazard Problem, 632

25-2 Regulation of Insurance Companies, 633

25-2a Assessment System, 633

25-2b Regulation of Capital, 633

25-2c Regulation of Failed Insurance Companies, 634

25-2d Regulation of Financial Services Offered, 634

25-2e Federal Insurance Office, 634

25-2f International Insurance Regulations, 634

25-3 Life Insurance Operations, 634

25-3a Ownership, 635

25-3b Types of Life Insurance, 635

25-3c Sources of Funds, 636

25-3d Uses of Funds, 637

25-3e Asset Management of Life Insurance Companies, 639

25-3f Interaction with Other Financial Institutions, 639

25-4 Other Types of Insurance Operations, 640

25-4a Property and Casualty Insurance, 641

25-4b Healthcare Insurance, 642

25-4c Business Insurance, 642

25-4d Bond Insurance, 643

25-4e Mortgage Insurance, 643

25-5 Exposure of Insurance Companies to Risk, 644

25-5a Interest Rate Risk, 644

25-5b Credit Risk, 644

25-5c Market Risk, 644

25-5d Liquidity Risk, 645

25-5e Exposure to Risk during the Credit Crisis, 645

25-5f Government Rescue of AIG, 645

25-6 Valuation of an Insurance Company, 646

25-6a Factors That Affect Cash Flows, 646

25-6b Factors That Affect the Required Rate of Return by Investors, 647

25-6c Indicators of Value and Performance, 648

26-1 Types of Pension Plans, 653

26-1a Defined-Benefit Plans, 653

26-1b Defined-Contribution Plans, 654

26-1c Comparing Pension Plans, 654

26-2 Pension Fund Participation in Financial Markets, 655

26-2a Governance by Pension Funds, 656

26-3 Regulation of Private Pension Plans, 656

26-3a Vesting of Private Pension Plans, 657

26-3b Transferability of Private Pension Plans, 657

26-3c Tax Benefits of Private Pension Plans, 657

26-3d Insurance on Private Pension Plans, 657

26-3e Underfunded Private Defined-Benefit Pensions, 658

26-4 Underfunded Public Defined-Benefit Pension Plans, 659

26-4a Overestimated Rate of Return, 659

26-4b Political Motivation, 659

26-4c Possible Solutions to Underfunded Pensions, 659

26-5 Corruption of Defined-Benefit Pension Funds, 661

26-5a Bribes to Trustees, 661

26-5b Payment of Excessive Benefits, 661

26-5c Ineffective Oversight by Trustees, 662

26-6 Pension Fund Management, 662

26-6a Asset Allocation of Pension Funds, 663

26-6b Matched versus Projective Funding Strategies, 664

26-7 Performance of Pension Funds, 664

26-7a Pension Fund’s Stock Portfolio Performance, 664

26-7b Pension Fund’s Bond Portfolio Performance, 665

26-7c Evaluation of Pension Fund Performance, 666

Part 7 integrative Problem: assessing the influence of Economic Conditio

ns across a Financial Conglomerate’s units, 670

Final review, 671

appendix a: Comprehensive Project, 677

appendix B: using Excel to Conduct analyses, 687

glossary, 691

index, 703

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