Financial Markets & Institutions, 13th Edition
By Jeff Madura
Contents:
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