Financial Markets and Institutions, Ninth Edition
By Frederic S. Mishkin and Stanley G. Eakins
Contents in Detail:
Contents on the Web 27
Preface 31
About the Authors 39
PART ONE INTRODUCTION
Chapter 1 Why Study Financial Markets and Institutions? 41
PREVIEW 41
Why Study Financial Markets? 42
Debt Markets and Interest Rates 42
The Stock Market 43
The Foreign Exchange Market 44
Why Study Financial Institutions? 46
Structure of the Financial System 46
Financial Crises 46
Central Banks and the Conduct of Monetary Policy 47
The International Financial System 47
Banks and Other Financial Institutions 47
Financial Innovation 47
Managing Risk in Financial Institutions 48
Applied Managerial Perspective 48
How We Will Study Financial Markets and Institutions 49
Exploring the Web 49
Collecting and Graphing Data 50
Web Exercise 50
Concluding Remarks 52
SUMMARY 52
KEY TERMS 53
QUESTIONS 53
QUANTITATIVE PROBLEMS 54
WEB EXERCISES 54
Chapter 2 Overview of the Financial System 55
PREVIEW 55
Function of Financial Markets 56
Structure of Financial Markets 58
Debt and Equity Markets 58
Primary and Secondary Markets 58
Exchanges and Over-the-Counter Markets 59
Money and Capital Markets 60
Internationalization of Financial Markets 60
International Bond Market, Eurobonds, and Eurocurrencies 60
GLOBAL Are U.S. Capital Markets Losing Their Edge? 61
World Stock Markets 62
Function of Financial Intermediaries: Indirect Finance 62
FOLLOWING THE FINANCIAL NEWS Foreign Stock Market Indexes 63
GLOBAL The Importance of Financial Intermediaries Relative
to Securities Markets: An International Comparison 63
Transaction Costs 63
Risk Sharing 64
Asymmetric Information: Adverse Selection and Moral Hazard 65
Economies of Scope and Conflicts of Interest 66
Types of Financial Intermediaries 67
Depository Institutions 67
Contractual Savings Institutions 68
Investment Intermediaries 70
Regulation of the Financial System 71
Increasing Information Available to Investors 72
Ensuring the Soundness of Financial Intermediaries 72
Financial Regulation Abroad 73
SUMMARY 74
KEY TERMS 75
QUESTIONS 75
WEB EXERCISES 76
PART TWO FUNDAMENTALS OF FINANCIAL MARKETS
Chapter 3 What Do Interest Rates Mean and What Is Their
Role in Valuation? 77
PREVIEW 77
Measuring Interest Rates 78
Present Value 78
Four Types of Credit Market Instruments 80
Yield to Maturity 81
GLOBAL Negative Interest Rates? Japan First, Then the United States, Then Europe 87
The Distinction Between Real and Nominal Interest Rates 88
MINI-CASE With TIPS, Real Interest Rates Have Become
Observable in the United States 91
The Distinction Between Interest Rates and Returns 91
Maturity and the Volatility of Bond Returns: Interest-Rate Risk 94
MINI-CASE Helping Investors Select Desired Interest-Rate Risk 95
Reinvestment Risk 95
Summary 96
THE PRACTICING MANAGER Calculating Duration to Measure Interest-Rate Risk 96
Calculating Duration 97
Duration and Interest-Rate Risk 101
SUMMARY 102
KEY TERMS 103
QUESTIONS 103
QUANTITATIVE PROBLEMS 103
WEB EXERCISES 105
Chapter 4 Why Do Interest Rates Change? 106
PREVIEW 106
Determinants of Asset Demand 107
Wealth 107
Expected Returns 107
Risk 108
Liquidity 110
Theory of Portfolio Choice 110
Supply and Demand in the Bond Market 110
Demand Curve 111
Supply Curve 112
Market Equilibrium 113
Supply-and-Demand Analysis 114
Changes in Equilibrium Interest Rates 114
Shifts in the Demand for Bonds 115
Shifts in the Supply of Bonds 118
CASE Changes in the Interest Rate Due to Expected Inflation: The Fisher Effect 120
CASE Changes in the Interest Rate Due to a Business Cycle Expansion 122
CASE Explaining the Current Low Interest Rates in Europe, Japan,
and the United States 123
THE PRACTICING MANAGER Profiting from Interest-Rate Forecasts 124
FOLLOWING THE FINANCIAL NEWS Forecasting Interest Rates 126
SUMMARY 126
KEY TERMS 126
QUESTIONS 126
QUANTITATIVE PROBLEMS 127
WEB EXERCISES 128
WEB APPENDICES 128
Chapter 5 How Do Risk and Term Structure Affect Interest Rates? 129
PREVIEW 129
Risk Structure of Interest Rates 130
Default Risk 130
Liquidity 133
CASE The Global Financial Crisis and the Baa-Treasury Spread 133
Income Tax Considerations 134
Summary 135
CASE Effects of the Bush Tax Cut and the Obama Tax
Increase on Bond Interest Rates 136
Term Structure of Interest Rates 137
FOLLOWING THE FINANCIAL NEWS Yield Curves 138
Expectations Theory 139
Market Segmentation Theory 143
Liquidity Premium Theory 144
Evidence on the Term Structure 147
Summary 148
MINI-CASE The Yield Curve as a Forecasting Tool for Inflation
and the Business Cycle 149
CASE Interpreting Yield Curves, 1980–2016 149
THE PRACTICING MANAGER Using the Term Structure to Forecast Interest Rates 150
SUMMARY 153
KEY TERMS 154
QUESTIONS 154
QUANTITATIVE PROBLEMS 155
WEB EXERCISES 156
Chapter 6 Are Financial Markets Efficient? 157
PREVIEW 157
The Efficient Market Hypothesis 158
Rationale Behind the Hypothesis 160
Evidence on the Efficient Market Hypothesis 161
Evidence in Favor of Market Efficiency 161
MINI-CASE An Exception That Proves the Rule: Raj Rajaratnam and Galleon 162
CASE Should Foreign Exchange Rates Follow a Random Walk? 164
Evidence Against Market Efficiency 165
Overview of the Evidence on the Efficient Market Hypothesis 167
THE PRACTICING MANAGER Practical Guide to Investing in the Stock Market 167
How Valuable Are Published Reports by Investment Advisers? 167
MINI-CASE Should You Hire an Ape as Your Investment Adviser? 168
Should You Be Skeptical of Hot Tips? 168
Do Stock Prices Always Rise When There Is Good News? 169
Efficient Markets Prescription for the Investor 169
Why the Efficient Market Hypothesis Does Not Imply
That Financial Markets Are Efficient 170
CASE What Do Stock Market Crashes Tell Us About the
Efficient Market Hypothesis? 171
Behavioral Finance 171
SUMMARY 172
KEY TERMS 173
QUESTIONS 173
QUANTITATIVE PROBLEMS 174
WEB EXERCISES 174
PART THREE FUNDAMENTALS OF FINANCIAL INSTITUTIONS
Chapter 7 Why Do Financial Institutions Exist? 175
PREVIEW 175
Basic Facts About Financial Structure Throughout The World 176
Transaction Costs 179
How Transaction Costs Influence Financial Structure 179
How Financial Intermediaries Reduce Transaction Costs 179
Asymmetric Information: Adverse Selection and Moral Hazard 180
The Lemons Problem: How Adverse Selection Influences
Financial Structure 181
Lemons in the Stock and Bond Markets 182
Tools to Help Solve Adverse Selection Problems 182
MINI-CASE The Enron Implosion 184
How Moral Hazard Affects the Choice Between Debt and
Equity Contracts 187
Moral Hazard in Equity Contracts: The Principal–Agent Problem 187
Tools to Help Solve the Principal–Agent Problem 188
How Moral Hazard Influences Financial Structure in Debt Markets 190
Tools to Help Solve Moral Hazard in Debt Contracts 190
Summary 192
CASE Financial Development and Economic Growth 194
MINI-CASE The Tyranny of Collateral 195
CASE Is China a Counter-Example to the Importance
of Financial Development? 196
Conflicts of Interest 197
What Are Conflicts of Interest and Why Do We Care? 197
Why Do Conflicts of Interest Arise? 197
MINI-CASE The Demise of Arthur Andersen 199
MINI-CASE Credit-Rating Agencies and the 2007–2009 Financial Crisis 200
What Has Been Done to Remedy Conflicts of Interest? 200
MINI-CASE Has Sarbanes-Oxley Led to a Decline
in U.S. Capital Markets? 202
SUMMARY 202
KEY TERMS 203
QUESTIONS 203
QUANTITATIVE PROBLEMS 204
WEB EXERCISES 205
Chapter 8 Why Do Financial Crises Occur and Why Are
They So Damaging to the Economy? 206
PREVIEW 206
What Is a Financial Crisis? 207
Agency Theory and the Definition of a Financial Crisis 207
Dynamics of Financial Crises 207
Stage One: Initial Phase 207
Stage Two: Banking Crisis 210
Stage Three: Debt Deflation 211
CASE The Mother of All Financial Crises: The Great Depression 211
Stock Market Crash 211
Bank Panics 211
Continuing Decline in Stock Prices 212
Debt Deflation 213
International Dimensions 213
CASE The Global Financial Crisis of 2007–2009 214
Causes of the 2007–2009 Financial Crisis 214
MINI-CASE Collateralized Debt Obligations (CDOs) 215
Effects of the 2007–2009 Financial Crisis 216
INSIDE THE FED Was the Fed to Blame for the Housing Price Bubble? 217
GLOBAL The European Sovereign Debt Crisis 220
Height of the 2007–2009 Financial Crisis 221
SUMMARY 222
KEY TERMS 223
QUESTIONS 223
WEB EXERCISES 223
WEB REFERENCES 224
PART FOUR CENTRAL BANKING AND THE CONDUCT OF MONETARY POLICY
Chapter 9 Central Banks 225
PREVIEW 225
Origins of the Central Banking System 226
GLOBAL Who Should Own Central Banks? 226
Variations in the Functions and Structures of Central Banks 227
The European Central Bank, the Euro System,
and the European System of Central Banks 228
Decision-Making Bodies of the ECB 230
How Monetary Policy is Conducted within the ECB 231
GLOBAL The Importance of the Bundesbank within the ECB 232
GLOBAL Are Non-Euro Central Banks Constrained by
Membership of the EU? 233
The Federal Reserve System 234
Difference between the ECB and the Fed 234
The Bank of England 235
GLOBAL Brexit and the BoE 236
Structure of Central Banks of Larger Economies 236
The Bank of Canada 237
The Bank of Japan 238
The People’s Bank of China 238
Structure and Independence of Central Banks of
Emerging Market Economies 239
Central Banks and Independence 240
The Case for Independence 240
The Case Against Independence 240
The Trend Toward Greater Independence 241
SUMMARY 241
KEY TERMS 242
QUESTIONS AND PROBLEMS 242
WEB EXERCISES 243
Chapter 10 Conduct of Monetary Policy 244
PREVIEW 244
How Fed Actions Affect Reserves in the Banking System 245
Open Market Operations 245
Discount Lending 246
The Market for Reserves and the Federal Funds Rate 247
Demand and Supply in the Market for Reserves 247
How Changes in the Tools of Monetary Policy Affect the Federal Funds Rate 249
CASE How the Federal Reserve’s Operating Procedures Limit
Fluctuations in the Federal Funds Rate 253
Conventional Monetary Policy Tools 254
Open Market Operations 254
INSIDE THE FED A Day at the Trading Desk 255
Discount Policy and the Lender of Last Resort 255
Reserve Requirements 258
Interest on Reserves 258
Nonconventional Monetary Policy Tools and Quantitative Easing 258
Liquidity Provision 259
INSIDE THE FED Fed Lending Facilities During the Global Financial Crisis 260
Large-Scale Asset Purchases 261
Quantitative Easing Versus Credit Easing 261
Forward Guidance 263
Negative Interest Rates on Banks’ Deposits 264
Monetary Policy Tools of the European Central Bank 265
Open Market Operations 265
Lending to Banks 265
Interest on Reserves 266
Reserve Requirements 266
The Price Stability Goal and the Nominal Anchor 266
The Role of a Nominal Anchor 267
The Time-Inconsistency Problem 267
Other Goals of Monetary Policy 268
High Employment and Output Stability 268
Economic Growth 269
Stability of Financial Markets 269
Interest-Rate Stability 269
Stability in Foreign Exchange Markets 270
Should Price Stability Be the Primary Goal of Monetary Policy? 270
Hierarchical vs. Dual Mandates 270
Price Stability as the Primary, Long-Run Goal of Monetary Policy 271
GLOBAL The European Central Bank’s Monetary Policy Strategy 272
Inflation Targeting 272
Advantages of Inflation Targeting 272
INSIDE THE FED Ben Bernanke and the Federal Reserve’s
Adoption of Inflation Targeting 273
Disadvantages of Inflation Targeting 274
Should Central Banks Respond to Asset-Price Bubbles?
Lessons from the Global Financial Crisis 275
Two Types of Asset-Price Bubbles 276
The Debate over Whether Central Banks Should Try to Pop Bubbles 277
THE PRACTICING MANAGER Using a Fed Watcher 279
SUMMARY 280
KEY TERMS 281
QUESTIONS 282
QUANTITATIVE PROBLEMS 283
WEB EXERCISES 283
PART FIVE FINANCIAL MARKETS
Chapter 11 The Money Markets 285
PREVIEW 285
The Money Markets Defined 286
Why Do We Need the Money Markets? 286
Money Market Cost Advantages 287
The Purpose of the Money Markets 288
Who Participates in the Money Markets? 289
U.S. Treasury Department 289
Federal Reserve System 289
Commercial Banks 290
Businesses 290
Investment and Securities Firms 291
Individuals 291
Money Market Instruments 292
Treasury Bills 292
CASE Discounting the Price of Treasury Securities to Pay the Interest 292
MINI-CASE Treasury Bill Auctions Go Haywire 295
Federal Funds 296
Repurchase Agreements 297
Negotiable Certificates of Deposit 298
Commercial Paper 299
Banker’s Acceptances 301
Eurodollars 302
GLOBAL Ironic Birth of the Eurodollar Market 302
Comparing Money Market Securities 303
Interest Rates 303
Liquidity 304
How Money Market Securities Are Valued 305
SUMMARY 306
KEY TERMS 306
QUESTIONS 306
QUANTITATIVE PROBLEMS 307
WEB EXERCISES 307
Chapter 12 The Bond Market 308
PREVIEW 308
Purpose of the Capital Market 309
Capital Market Participants 309
Capital Market Trading 310
Types of Bonds 310
Treasury Notes and Bonds 310
Treasury Bond Interest Rates 311
Treasury Inflation-Protected Securities (TIPS) 313
Treasury STRIPS 313
Agency Bonds 313
CASE The 2007–2009 Financial Crisis and the Bailout of Fannie
Mae and Freddie Mac 314
Municipal Bonds 315
Risk in the Municipal Bond Market 317
Corporate Bonds 317
Characteristics of Corporate Bonds 318
Types of Corporate Bonds 320
Financial Guarantees for Bonds 323
Oversight of the Bond Markets 324
Current Yield Calculation 324
Current Yield 325
Finding the Value of Coupon Bonds 326
Finding the Price of Semiannual Bonds 327
Investing in Bonds 329
SUMMARY 330
KEY TERMS 331
QUESTIONS 331
QUANTITATIVE PROBLEMS 331
WEB EXERCISE 332
Chapter 13 The Stock Market 333
PREVIEW 333
Investing in Stocks 334
Common Stock vs. Preferred Stock 334
How Stocks Are Sold 335
Computing the Price of Common Stock 339
The One-Period Valuation Model 339
The Generalized Dividend Valuation Model 340
The Gordon Growth Model 341
Price Earnings Valuation Method 342
How the Market Sets Security Prices 343
Errors in Valuation 344
Problems with Estimating Growth 344
Problems with Estimating Risk 345
Problems with Forecasting Dividends 345
CASE The 2007–2009 Financial Crisis and the Stock Market 346
CASE The September 11 Terrorist Attack, the Enron Scandal, and the Stock Market 346
Stock Market Indexes 347
MINI-CASE History of the Dow Jones Industrial Average 347
Buying Foreign Stocks 350
Regulation of the Stock Market 350
The Securities and Exchange Commission 350
SUMMARY 351
KEY TERMS 352
QUESTIONS 352
QUANTITATIVE PROBLEMS 352
WEB EXERCISES 353
Chapter 14 The Mortgage Markets 354
PREVIEW 354
What Are Mortgages? 355
Characteristics of the Residential Mortgage 356
Mortgage Interest Rates 356
CASE The Discount Point Decision 357
Loan Terms 359
Mortgage Loan Amortization 360
Types of Mortgage Loans 361
Insured and Conventional Mortgages 361
Fixed- and Adjustable-Rate Mortgages 362
Other Types of Mortgages 362
Mortgage-Lending Institutions 364
Loan Servicing 365
E-FINANCE Borrowers Shop the Web for Mortgages 366
Secondary Mortgage Market 366
Securitization of Mortgages 367
What Is a Mortgage-Backed Security? 367
Types of Pass-Through Securities 369
Subprime Mortgages and CDOs 370
The Real Estate Bubble 371
SUMMARY 372
KEY TERMS 372
QUESTIONS 372
QUANTITATIVE PROBLEMS 373
WEB EXERCISES 374
Chapter 15 The Foreign Exchange Market 375
PREVIEW 375
Foreign Exchange Market 376
What Are Foreign Exchange Rates? 377
Why Are Exchange Rates Important? 377
FOLLOWING THE FINANCIAL NEWS Foreign Exchange Rates 377
How Is Foreign Exchange Traded? 378
Exchange Rates in the Long Run 378
Law of One Price 379
Theory of Purchasing Power Parity 379
Why the Theory of Purchasing Power Parity Cannot
Fully Explain Exchange Rates 381
Factors That Affect Exchange Rates in the Long Run 381
Exchange Rates in the Short Run: A Supply and Demand Analysis 383
Supply Curve for Domestic Assets 383
Demand Curve for Domestic Assets 384
Equilibrium in the Foreign Exchange Market 385
Explaining Changes in Exchange Rates 385
Shifts in the Demand for Domestic Assets 385
Recap: Factors That Change the Exchange Rate 388
CASE Effect of Changes in Interest Rates on
the Equilibrium Exchange Rate 390
CASE Why Are Exchange Rates So Volatile? 392
CASE The Dollar and Interest Rates 392
CASE The Global Financial Crisis and the Dollar 394
THE PRACTICING MANAGER Profiting from Foreign Exchange Forecasts 395
SUMMARY 396
KEY TERMS 396
QUESTIONS 396
QUANTITATIVE PROBLEMS 397
WEB EXERCISES 398
Chapter 15 Appendix The Interest Parity Condition 399
Comparing Expected Returns on Domestic and Foreign Assets 399
Interest Parity Condition 401
Chapter 16 The International Financial System 403
PREVIEW 403
Intervention in the Foreign Exchange Market 404
Foreign Exchange Intervention and Reserves in the Banking System 404
INSIDE THE FED A Day at the Federal Reserve Bank of New York’s
Foreign Exchange Desk 405
Unsterilized Intervention 406
Sterilized Intervention 406
Balance of Payments 408
GLOBAL Why the Large U.S. Current Account Deficit Worries Economists 409
Exchange Rate Regimes in the International Financial System 409
Fixed Exchange Rate Regimes 409
How a Fixed Exchange Rate Regime Works 410
The Policy Trilemma 412
Monetary Unions 413
GLOBAL Will the Euro Survive? 414
Currency Boards and Dollarization 414
Speculative Attacks 414
GLOBAL Argentina’s Currency Board 415
Managed Float 415
GLOBAL Dollarization 416
CASE The Foreign Exchange Crisis of September 1992 416
THE PRACTICING MANAGER Profiting from a Foreign Exchange Crisis 418
CASE How Did China Accumulate over $3 Trillion of International Reserves? 419
Capital Controls 420
Controls on Capital Outflows 420
Controls on Capital Inflows 420
The Role of the IMF 421
Should the IMF Be an International Lender of Last Resort? 421
SUMMARY 422
KEY TERMS 422
QUESTIONS 423
QUANTITATIVE PROBLEMS 424
WEB EXERCISE 424
PART SIX THE FINANCIAL INSTITUTIONS INDUSTRY
Chapter 17 Banking and the Management of Financial
Institutions 425
PREVIEW 425
The Bank Balance Sheet 426
Liabilities 426
Assets 428
Basic Banking 429
General Principles of Bank Management 432
Liquidity Management and the Role of Reserves 432
Asset Management 435
Liability Management 436
Capital Adequacy Management 437
THE PRACTICING MANAGER Strategies for Managing Bank Capital 439
CASE How a Capital Crunch Caused a Credit Crunch During the
Global Financial Crisis 440
Off-Balance-Sheet Activities 440
Loan Sales 441
Generation of Fee Income 441
Trading Activities and Risk Management Techniques 441
CONFLICTS OF INTEREST Barings, Daiwa, Sumitomo, Société Générale, and
J.P. Morgan Chase: Rogue Traders and the Principal–Agent Problem 442
Measuring Bank Performance 443
Bank’s Income Statement 444
Measures of Bank Performance 446
Recent Trends in Bank Performance Measures 446
SUMMARY 448
KEY TERMS 449
QUESTIONS 449
QUANTITATIVE PROBLEMS 449
WEB EXERCISES 450
Chapter 18 Financial Regulation 451
PREVIEW 451
Asymmetric Information as a Rationale for Financial Regulation 452
Government Safety Net 452
GLOBAL The Spread of Government Deposit Insurance
Throughout the World: Is This a Good Thing? 454
Types of Financial Regulation 457
Restrictions on Asset Holdings 457
Capital Requirements 458
Prompt Corrective Action 459
Financial Supervision: Chartering and Examination 459
GLOBAL Where Is the Basel Accord Heading After the Global Financial Crisis? 460
Assessment of Risk Management 461
Disclosure Requirements 462
Consumer Protection 463
MINI-CASE Mark-to-Market Accounting and the Global Financial Crisis 464
Restrictions on Competition 464
MINI-CASE The Global Financial Crisis and Consumer
Protection Regulation 465
Macroprudential Versus Microprudential Supervision 466
E-FINANCE Electronic Banking: New Challenges for Bank Regulation 466
Summary 467
GLOBAL International Financial Regulation 468
Banking Crises Throughout the World in Recent Years 471
“Déjà Vu All Over Again” 471
The Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010 473
Dodd-Frank 473
Too-Big-to-Fail and Future Regulation 474
What Can Be Done About the Too-Big-to-Fail Problem? 474
Other Issues for Future Regulation 475
SUMMARY 476
KEY TERMS 477
QUESTIONS 477
QUANTITATIVE PROBLEMS 477
WEB EXERCISES 478
WEB APPENDIX 478
Chapter 19 Banking Industry: Structure and Competition 479
PREVIEW 479
Historical Development of the Banking System 480
Multiple Regulatory Agencies 482
Financial Innovation and the Growth of the Shadow Banking System 482
Responses to Changes in Demand Conditions: Interest Rate Volatility 483
Responses to Changes in Supply Conditions: Information Technology 484
E-FINANCE Will “Clicks” Dominate “Bricks” in the Banking Industry? 486
E-FINANCE Why Are Scandinavians So Far Ahead of Americans
in Using Electronic Payments and Online Banking? 487
E-FINANCE Are We Headed for a Cashless Society? 488
Securitization and the Shadow Banking System 489
Avoidance of Existing Regulations 491
MINI-CASE Bruce Bent and the Money Market Mutual Fund Panic of 2008 493
THE PRACTICING MANAGER Profiting from a New Financial Product:
A Case Study of Treasury Strips 493
Financial Innovation and the Decline of Traditional Banking 495
Structure of the U.S. Banking Industry 498
Restrictions on Branching 499
Response to Branching Restrictions 500
Bank Consolidation and Nationwide Banking 501
E-FINANCE Information Technology and Bank Consolidation 503
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 503
What Will the Structure of the U.S. Banking Industry Look Like in the Future? 504
Are Bank Consolidation and Nationwide Banking Good Things? 504
Separation of the Banking and Other Financial Service Industries 505
Erosion of Glass-Steagall 505
The Gramm-Leach-Bliley Financial Services Modernization Act of 1999:
Repeal of Glass-Steagall 506
Implications for Financial Consolidation 506
MINI-CASE The Global Financial Crisis and the Demise of Large, Free-Standing
Investment Banks 507
Separation of Banking and Other Financial Services Industries
Throughout the World 507
Thrift Industry 508
Savings and Loan Associations 508
Mutual Savings Banks 508
Credit Unions 509
International Banking 509
Eurodollar Market 510
Structure of U.S. Banking Overseas 510
Foreign Banks in the United States 511
SUMMARY 512
KEY TERMS 513
QUESTIONS 513
WEB EXERCISES 514
Chapter 20 The Mutual Fund Industry 515
PREVIEW 515
The Growth of Mutual Funds 516
The First Mutual Funds 516
Benefits of Mutual Funds 516
Ownership of Mutual Funds 517
Mutual Fund Structure 520
Open- Versus Closed-End Funds 520
CASE Calculating a Mutual Fund’s Net Asset Value 521
Organizational Structure 522
Investment Objective Classes 522
Equity Funds 522
Bond Funds 524
Hybrid Funds 525
Money Market Funds 525
Index Funds 527
Fee Structure of Investment Funds 528
Regulation of Mutual Funds 529
Hedge Funds 530
MINI-CASE The Long Term Capital Debacle 532
Conflicts of Interest in the Mutual Fund Industry 533
Sources of Conflicts of Interest 533
Mutual Fund Abuses 533
CONFLICTS OF INTEREST Many Mutual Funds Are Caught Ignoring
Ethical Standards 534
CONFLICTS OF INTEREST SEC Survey Reports Mutual Fund Abuses Widespread 535
Government Response to Abuses 536
SUMMARY 537
KEY TERMS 537
QUESTIONS 537
QUANTITATIVE PROBLEMS 538
WEB EXERCISES 539
Chapter 21 Insurance Companies and Pension Funds 540
PREVIEW 540
Insurance Companies 541
Fundamentals of Insurance 541
Adverse Selection and Moral Hazard in Insurance 542
Selling Insurance 543
MINI-CASE Insurance Agent: The Customer’s Ally 543
Growth and Organization of Insurance Companies 544
Types of Insurance 544
Life Insurance 545
Health Insurance 549
Property and Casualty Insurance 551
Insurance Regulation 552
THE PRACTICING MANAGER Insurance Management 553
Screening 553
Risk-Based Premium 554
Restrictive Provisions 554
Prevention of Fraud 554
Cancellation of Insurance 555
Deductibles 555
Coinsurance 555
Limits on the Amount of Insurance 555
Summary 556
Credit Default Swaps 556
CONFLICTS OF INTEREST The AIG Blowup 557
Pensions 557
CONFLICTS OF INTEREST The Subprime Financial Crisis and
the Monoline Insurers 558
Types of Pensions 558
Defined-Benefit Pension Plans 558
Defined-Contribution Pension Plans 559
Private and Public Pension Plans 560
MINI-CASE Power to the Pensions 560
Regulation of Pension Plans 564
Employee Retirement Income Security Act 564
Individual Retirement Plans 566
The Future of Pension Funds 566
SUMMARY 567
KEY TERMS 567
QUESTIONS 567
QUANTITATIVE PROBLEMS 568
WEB EXERCISES 569
Chapter 22 Investment Banks, Security Brokers and
Dealers, and Venture Capital Firms 570
PREVIEW 570
Investment Banks 571
Background 571
Underwriting Stocks and Bonds 572
Equity Sales 576
Mergers and Acquisitions 577
Securities Brokers and Dealers 578
Brokerage Services 579
Securities Dealers 581
MINI-CASE Example of Using the Limit-Order Book 582
Regulation of Securities Firms 582
Relationship Between Securities Firms and Commercial Banks 584
Private Equity Investment 584
Venture Capital Firms 584
E-FINANCE Venture Capitalists Lose Focus with Internet Companies 589
Private Equity Buyouts 589
Advantages to Private Equity Buyouts 589
Life Cycle of the Private Equity Buyout 590
SUMMARY 590
KEY TERMS 591
QUESTIONS 591
QUANTITATIVE PROBLEMS 592
WEB EXERCISES 593
PART SEVEN THE MANAGEMENT OF FINANCIAL INSTITUTIONS
Chapter 23 Risk Management in Financial Institutions 594
PREVIEW 594
Managing Credit Risk 595
Screening and Monitoring 595
Long-Term Customer Relationships 596
Loan Commitments 597
Collateral 597
Compensating Balances 598
Credit Rationing 598
Managing Interest-Rate Risk 599
Income Gap Analysis 600
Duration Gap Analysis 602
Example of a Nonbanking Financial Institution 607
Some Problems with Income Gap and Duration Gap Analyses 609
THE PRACTICING MANAGER Strategies for Managing Interest-Rate Risk 610
SUMMARY 611
KEY TERMS 611
QUESTIONS 611
QUANTITATIVE PROBLEMS 612
WEB EXERCISES 614
Chapter 24 Hedging with Financial Derivatives 615
PREVIEW 615
Hedging 616
Forward Markets 616
THE PRACTICING MANAGER Hedging Interest-Rate Risk
with Forward Contracts 616
Interest-Rate Forward Contracts 616
Pros and Cons of Forward Contracts 617
Financial Futures Markets 618
Financial Futures Contracts 618
FOLLOWING THE FINANCIAL NEWS Financial Futures 619
THE PRACTICING MANAGER Hedging with Financial Futures 620
Organization of Trading in Financial Futures Markets 622
Globalization of Financial Futures Markets 622
Explaining the Success of Futures Markets 623
MINI-CASE The Hunt Brothers and the Silver Crash 625
Detail
THE PRACTICING MANAGER Hedging Foreign Exchange Risk with
Forward and Futures Contracts 626
Hedging Foreign Exchange Risk with Forward Contracts 626
Hedging Foreign Exchange Risk with Futures Contracts 627
Stock Index Futures 627
Stock Index Futures Contracts 628
FOLLOWING THE FINANCIAL NEWS Stock Index Futures 628
THE PRACTICING MANAGER Hedging with Stock Index Futures 629
Options 630
Option Contracts 630
Profits and Losses on Option and Futures Contracts 631
Factors Affecting the Prices of Option Premiums 634
Summary 635
THE PRACTICING MANAGER Hedging with Futures Options 635
Interest-Rate Swaps 637
Interest-Rate Swap Contracts 637
THE PRACTICING MANAGER Hedging with Interest-Rate Swaps 638
Advantages of Interest-Rate Swaps 639
Disadvantages of Interest-Rate Swaps 639
Financial Intermediaries in Interest-Rate Swaps 640
Credit Derivatives 640
Credit Options 641
Credit Swaps 641
Credit-Linked Notes 642
CASE Lessons from the Global Financial Crisis: When Are Financial
Derivatives Likely to Be a Worldwide Time Bomb? 642
SUMMARY 644
KEY TERMS 644
QUESTIONS 645
QUANTITATIVE PROBLEMS 645
WEB EXERCISE 647
WEB APPENDICES 647
Glossary 649
Index 667