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Contents1

Part One The Financial System in Perspective1

Chapter One The Role of the Financial Svstem in the Global Economy1

The Economy and the Financial System2

Flows within the Economy System2

The Role of Markets in the Economic System2

Types of Markets3

The Financial Markets and the Financial3

System Channel for Sarings and Inrestmem3

Functions Performed by the Financial System and the Financial Markets5

Sarings Function6

Wealth Function6

Liquidity Function7

Credit Function7

Payments Function7

Risk Function8

Policy Function8

Types of Financial Markets within the Financial System9

The Money Market versus the Capital Market9

Divisions of the Money and Capital Markets11

Open versus Negotiated Markets12

Primary versus Secondary Markets12

Spot versus Futures.Forward. and Option Markets14

Factors Tying All Financial Markets Together15

The Dynamic Financial System17

The Plan of This Book17

Key Terms and Concepts in This Chapter19

Study Questions19

Problems20

Selected References22

Chapter Two Financial Assets, Money, and Financial Transactions23

The Creation of Financial Assets24

Characteristics of Financial Assets24

Different Kinds of Financial Assets24

The Creation Process for Financial Assets25

Financial Assets and the Financial System27

Lending and Borrowing in the Financial System29

Money as a Financial Asset31

What is Money?31

The Functions of Money31

The Evolution of Financial Transactions34

Direct Finance34

Semidirect finance35

Indirect Finance35

Relative Size and Importance of Major Financial Institutions37

Classification of Financial Institutions38

Portfolio Decisions by Financial Intermediaries and Other Financial Institutions39

Disintermediation of Funds39

New types of Disintermediation40

Summary41

Key Terms and Concepts in This Chapter41

Study Questions41

Problems42

Selected References43

Chapter Three Sources of Information for Financial Decision Making in the Money and Capital Markets44

Efficient Markets and Asymmetric information45

The Efficient Markets Hypothesis45

The Concept of symmetric Information48

Problems Informational Asymmetries Can Create:Lemons and Plums49

Problems Asymmetries Can create:The Problem of Adverse Selection50

Debt Security Prices and Yields53

Stock Prices and Dividend Yields56

Information on Security Issuers59

General Economic and Financial Conditions64

Social Accounting Data66

National Income Accounts66

The Flow of Funds Accounts67

Summary78

Key Terms and Concepts in This Chapter79

Study Questions79

Problems79

Selected References81

Part TWO The Management and Regulation of Financial Institutions81

Chapter Four The Commercial Banking Industry82

The Structure of U.S. Commercial Banking83

A Trend Ioward Consolidation84

Branch Banking84

Bank Holding Companies85

International Banking86

Bank Failures87

Changing Technology88

Portfolio Characteristics of Commercial Banks89

Cash and Due from Banks Primary Reserves89

Security Holdings and Secondary Reserves92

Loans92

Deposits93

Nondeposit Sources of Funds94

Equity Capital95

Revenues and Expenses95

Money Creation and Destruction by Banks98

Reserve Requirements and Excess Reserves98

The Creation if Money and Credit100

Destruction of Deposits and Reserves104

Implications of Money Creation and Destruction105

Summary105

Key Terms and Concepts in This Chapter105

Study Questions105

Problems106

Selected References107

Chapter Five Nonbank Thrift Institutions: Credit Unions,Savings and Loan Associations, Savings Banks, and Money Market Mutual Funds109

Credit Unions110

Credit Union Membership111

Size of Credit Unions111

New Services Offered112

A Strong Competitive Force113

Savings and Loan Associations113

Origins113

How Funds Are Raised and Allocated114

Trends in Revenues and Costs116

Possible Remedies for the Industry's Problems120

Savings Banks120

Number and Distribution of Savings Banks121

How Funds Are Raised and Allocated121

Current Trends and Future Problems122

Money Market Funds122

Summary129

Key Terms and Concepts in This Chapter129

Study Questions129

Problems130

Selected References131

Chapter Six Insurance Companies. Pension Funds, and Other Financial Institutions132

Life Insurance Companies132

The Insurance Principle133

Investments of Life Insurance Companies133

Sources of Life Insurance Company Funds137

Structure and Growth of the Life Insurance Industry137

New Services137

Property-Casualty Insurance Companies140

Makeup of the Property-Casualty (P/C) Insurance Industry140

Changing Risk Patterns in Property/Liability Coverage140

Investments by Property-Casualty (P/C) Companies141

Sources of income142

Business Cycles,Inflation,and Competition142

Pension Funds143

Growth of Pension Funds144

Investment Strategies of Pension Funds146

Pension Fund Assets147

Factors Affecting the Future Growth of Pension Funds147

Finance Companies149

Different Finance Companies for Different Purposes150

Growth of Finance Companies150

Methods of Industry Financing151

Recent Changes in the Character of the Finance Company Industry152

Investment Companies152

The Background of Investment Companies152

Tax Status of the Industry154

Open-End and Closed-End Investment Companies154

Goals and Earnings of Investment Companies155

Other FinanciaI Institutions156

Trends Affecting All Financial Institutions Today160

Summary161

Key Terms and Concepts in This Chapter162

Study Questions162

Problems162

Selected References163

Chapter Seven The Regulation of Financial Institutions164

The Reasons behind the Regulation of Financial Institutions165

Does Regulation Benefit or Harm Financial Institutions?166

The Regulation of Commercial Banks167

The Federal Reserve System168

The Comptroller of the Currency168

Federal Deposit lnsurance Corporation168

State Banking Commissions170

Regulations Controlling the Geographic Expansion of Banks170

Regulation of the Services Banks Can Offer174

The Rise of Disclosure Laws in Banking176

The Growing Importance of Capital Regulation in Banking176

The Unfinished Agenda for Banking Regulation178

The Regulation of Nonbank Thrift Institutions180

Credit Unions180

Savings and Loans181

Savings Banks185

Money Market Funds185

The Regulation of lnsurance Companies186

The Regulation of Pension Funds186

The Regulation of Finance Companies187

The Regulation of Investment Companies187

An Overview of Trends in the Regulation of Financial Institutions188

Key Terms and Concepts in This Chapter190

Study Questions191

Problems191

Selected References191

Part Three Interest Rates and Security Prices191

Chapter Eight Interest Rates in the Financial System192

Functions of the Rate of Interest in the Economy193

The Classical Theory of Interest Rates193

Saving by Households194

Saving by Business Firms194

Saving by Government195

The Demand for Investment Funds195

The Equilibrium Rate of Interest in the Classical Theory of Interest198

Limitarions of the Classical Theory of Interest200

The Liquidity Preference Theory200

The Demand for Liquidity200

The Supply of Money202

The Equitibrium Rate of Interest in Liquidity Preference Theory203

Limitations of the Liquidity Preference Theory204

The Loanable Funds Theory205

Consumer Demand for Loanable Funds205

Domestic Business Demand for Loanable Funds205

Government Demand for Loanable Funds205

Foreign Demand for Lounable Funds206

Total Demand for Loanable Funds206

The Supply of Loanable Funds206

Total Supply of Loanable Funds208

The Equilibrium Rate of Interest in the Loanable Funds Theory208

The Rational Expectations Theory211

Summary215

Key Terms and Concepts in This Chapter216

Study Questions216

Problems217

Selected References218

Chapter Nine Relationships between Interest Rates and Security Prices219

Units of Measurement for lnterest Rates and Security Prices219

Definition of Interest Rates219

Basis Points220

Security Prices220

Measures of the Rate of Return,or Yield, on a Loan or Security221

Coupon Rate221

Current Yield222

Yield to Maturity222

Holding-Period Yield223

Calculating Yields to Maturity and Holding-Period Yields224

Yield-Price Relationships227

Interest Rates Charged by Institutional Lenders229

The Simple Interest Method230

Add-On Rate of Interest230

Discount Method231

Home Mortgage Interest Rate231

Annual Percentage Rate(APR)232

Compound Interest233

The Annual Percentage Yield(APY)235

Summary236

Key Terms and Concepts in This Chapter236

Study Questions236

Problems237

Selected References238

Chapter Ten Inflation, Yield Curves, and Duration239

Inflation and Interest Rates240

The Correlation between Inflation and Interest Rates240

The Nominal and Real Interest Rates240

The Fisher Effect241

The Harrod-Keynes Effect Of Inflation242

Alternative Views on Inflation and Interest Rates243

Inflation and Stock Prices248

The Maturity of a Loan250

The Yield Curve and the Term Structure of Interest Rates250

Types of Yield Curves250

The Unbiased Expectations Hypothesis251

The Role of Expectations in Shaping the Yield Curve253

Relative Changes in Long-Term Interest Rates253

Policy Implications of the Unbiased Expectations Hypothesis254

The Liquidity Premium View Of the Yield Curve255

The Segmented-Markets or Hedging-Pressure Argument255

Policy implications of the Segmented-Markets Theory256

The Preferred Habitat or Composite Theory of the Yield Curve257

Research Evidence on Yield-Curve258

Theories258

Uses of the Yield Curve261

Duration: A Different Approach to Maturity262

The Price Elasticity of a Debt Security262

The Impact of Varying Coupon Rates263

An Alternative Maturity Index for a Security:Duration264

Uses of Duration265

Limitations of Duration267

Summary268

Key Terms and Concepts in This Chapter269

Study Questions269

Problems270

Selected References271

Chapter Eleven Default Risk, Taxes, and Other Factors Affecting Interest Rates273

Marketability274

Liquidity274

Default Risk and Interest Rates275

The Premium for Default Risk275

The Expected Rate of Return or Yield on a Risky Security276

AnticiPated Loss and Default-Risk Premiums276

Factors Influencing Default-Risk Premiums277

The Rise and Fall of Junk Bonds283

A Summary of the Default Risk, Interest Rate Relationship284

Call Privileges284

Calculating the Yields on Called Securities284

Advantages and Disadvantages of the Call Privilege287

The Call Premium and Interest Rate Expectations287

Research Evidence288

Effect of Coupon Rates on Call Risk288

Prepayment Risk and Interest Rates on Loan-Backed Securities289

Taxation of Security Returns290

The Tax Treatment of Capital Gains290

Treatment of Capital Losses292

Tax-Exempt Securities292

Convertible Securities294

The Structure of Interest Rates295

Key Terms and Concepts in This Chapter296

Study Questions296

Problems297

Selected References298

Chapter Twelve Interest Rate Forecasting and Hedging against Interest Rate Risk299

The Influence of the Business Cycle in Shaping Interest Rates300

Relative Movements in Short-and Long-Term Interest Rates and Security Prices over the Business Cycle301

Seasonality302

Forecasting Interest Rates: Advantages and Problems303

Advantages of Rate Forecasting303

Problems in Forecasting Interest Rates303

Approaches to Modem Interest Rate Forecasting304

Money Supply APProaches304

Inflation and the Fisher Effect305

Econometric Models306

The Flow of Funds Accounts as a Source of Forecasting Information307

Following the Forward Calendar of New Security Offerings308

Market Expectations and Implied Rate Forecasting308

The Consensus Forecast310

Interest-Rate-Risk Hedging Strategies310

Duration310

Stripped Securities311

GAP Management312

Interest Rate Caps and Collars313

Interest Rate Insurance313

Loan Options314

Interest Rate SWAPS314

Summary318

Key Terms and Concepts in This Chapter319

Study Questions319

Problems320

Selected References321

Chapter Thirteen FinanciaI Futures and Options Contracts323

The Nature of Futures Trading323

General Principles of Hedging324

Opening and Closing a Hedge324

Why Hedging Can Be Effective325

Risk Selection through Hedging326

FinanciaI Futures326

The Purpose of Trading in Financial Futures327

Securities Used in Financial Futures Contracts328

U.S. Treasury Bonds and Notes329

U.S. Treasury Bills330

Eurodollar Time Deposits331

Other Money Market Futures Contracts331

Municipal State and Local Government Bonds331

New Foreign-Bond-Index Futures Contracts331

Stock Index Futures332

Types of Hedging in the Financial Futures Market333

The Long (or Buying) Hedge333

The Short (or Selling)Hedge334

Cross Hedging335

The Mechanics of Futures Trading336

Payoff Diagrams for Long and Short Futures Contracts338

Options Contracts on Financial Futures339

Basic Types of Option Contracts339

Option Contracts for Money Market and Capital Market Instruments340

Uses of Options on futures Contracts341

Payoff Diagrams for Valuing Options343

The Black-Scholes Model for Valuing Options347

Traders Active in the Futures and Options Markets348

Potential Benefits from the Futures and Options Markets349

Summary352

Key Terms and Concepts in This Chapter353

Study Questions353

Problems354

Selected References355

Part Four The Money Market356

Chapter Fourteen Characteristics of the Money Market356

Characteristics of the Money Market357

The Need for a Money Market357

Borrowers and Lenders in the Money Market358

The Goals of Money Market Investors358

Types of Investment Risk359

Money Market Maturities360

Depth and Breadth of the Money Market360

Federal funds versus Clearinghouse Funds361

A Market for Large Borrowers and Lenders361

The Volume of Money Market Securities363

The Pattern of Interest Rates in the Money Market364

Summary366

Key Terms and Concepts in This Chapter367

Study Questions367

Problems367

Selected References368

Chapter Fifteen Treasury Bills, Dealer Loans, and Repurchase Agreements369

U.S. Treasury Bills370

Volume of Bills Outstanding370

Types of Treasury Bills371

How Bills Are Sold371

Results of a Recent Bill Auction372

Calculating the Yield on Bills373

Market Interest Rates on Treasury Bills375

Investors in Treasury Bills377

Primary Dealers, Dealer Loans, and Repurchase Agreements378

Scandal Rocks the Market for Government Securities378

Proposals for New Ways to Auction Government Securities379

Dealers Reliance on Borrowed Funds381

Demand Loans381

Repurchase Agreements381

Sources of Dealer Income383

Dealer positions in Securities384

Changing Sources of Dealer Financing385

Dealer Transactions and Government Security Brokers385

Summary386

Key Terms and Concepts in This Chapter387

Study Questions387

Problems387

Selected References388

Chapter Sixteen Federal Funds, Negotiable CDs, and Loans from the Discount Window389

Federal Funds390

Nature of Federal Funds390

Use of the Federal Funds Market to Meet Deposit Reserve Requirements391

Mechanics of Federal Funds Trading392

Volume of Borrowings in the Funds Market393

Rates on Federal Funds393

Federal Funds and Government Policy394

Negotiable Certificates of Deposit394

Growth of CDs396

Terms Attached to CDs396

Buyers of CDs397

Cds in Liability Management398

New Types of CDs398

Loans from the Federal Reserve's Discount Window400

Causes and Effects of Borrowing from the Discount Window400

Collateral for Discount Window Loans401

Restrictions on Federal Reserve Credit401

The Federal Reserve's Discount Rate402

Concluding Comment on Bank Activity in the Money Market404

Key Terms and Concepts in This Chapter405

Study Questions405

Problems406

Selected References406

Chapter Seventeen Commercial Paper and Federal Agency Securities407

Commercial Paper408

What Is Commercial PaPer?408

Types of Commercial Paper408

Recent Growth Of Commercial PaPer410

Maturities and Rates of Return on Commercial PaPer413

Changing Yields on PaPer Issues413

Advantages of Issuing Commercial PaPer414

Possible Disadvantages from Issuing Commercial PaPer415

Principal investors415

Continuing Innovation in the PaPer Market416

Commercial PaPer Ratings417

Dealers in PaPer418

Federal Agency Securities418

Types of Federal Credit Agencies419

Growth Of the Agency Market420

Terms on Agency Securities421

The Marketing Of Agency Issues422

Summary423

Key Terms and Concepts in This Chapter423

Study Questions424

Problems424

Selected References425

Chapter Eighteen International Money Market Instruments:Bankers' Acceptances and Eurodollars426

Bankers' Acceptances427

Why AccePtances Are Used in International Trade427

How AccePtances Arise428

Recent Growth of Acceptance Financing429

Acceptance Rates431

Investors in Acceptances432

Eurodollars432

What is a Eurodollar?433

The Creation of Eurodollars433

Eurodollar Maturities and Risks436

The Supply of Eurodollars437

Eurodollars in Domestic Bank Operations437

Recent Innovations in the Eurodollar Market439

Benefits and Costs of the Eurodollar Market439

Summary440

Key Terms and Concepts in This Chapter441

Study Questions441

Problems441

Selected References442

Part Five443

Central Banking and Monetary Policy443

Chapter Nineteen Central Banking and the Role of the Federal Reserve443

The Role of Central Banks in the Economy444

Control of the Money Supply444

Stabilizing the Money and Capital Markets444

Lender of Last Resort445

Maintaining and Improving the Payments Mechanism445

The Goals and Channels of Central Banking445

The Channels through Which Central Banks Work446

The History of the Federal Reserve System447

Problems in the Early U.S. Banking System449

Creation of the Federal Reserve System450

The Early Structure of the Federal Reserve System451

Goals and Policy Tools of the Federal Reserve System451

How the Fed is Organized452

Board of Governors of the Federal Reserve System452

The Federal Open Market Committee and Manager of the System Open Market Account453

The Federal Reserve Banks454

The Member Banks of the Federal Reserve System455

Roles of the Federal Reserve System Today458

The Clearing and Collection of Checks and Other Means of Payment458

Issuing Currency and Com and Providing Other Services459

Maintaining a Sound Banking and Financial system459

Serving as the Federal Governments Fiscal Agent460

Carrying out Monetary Policy460

Providing information to the Public460

Summary460

Key Terms and Concepts in This Chapter461

Study Questions462

Selected References462

Chapter Twenty The Tools of Monetary Policy463

Reserves and Money—Targets of Federal Reserve Policy463

The Composition of Reserves464

The Deposit Multiplier464

The Money Multiplier466

General versus Selective Credit Controls468

The General Credit Controls of the Fed468

Reserve Reauirements468

Changes in the Federal Reserves Discount Rate471

Open Market Operations474

Selective Credit Controls Used by the Fed481

Moral Suasion by Federal Reserve Officials483

Margin Requirements483

Summary484

Key Terms and Concepts in This Chapter485

Study Questions485

Problems485

Selected References486

Chapter Twenty-One Indicators and Goals of Monetary Policy487

Factors Influencing the Reserves of the Banking System488

Actions of the Public Affecting Reserves488

Operations of the Treasury and Foreign Investors Affecting Reserves489

Federal Reserve Operations Affecting reserves490

The Heart of The Monetary Policy Process Controlling Reserves to Achieve Desired Target Levels490

The Federal Reserve Statement490

Factors Supplying Reserves491

Factors Absorbing Reserves492

Measures of the Money Supply492

Money Supply Measures493

Federal Reserve Control of Money Supply Growth494

Achieving the Fed's Money Supply Targets496

Money Market Indicators496

The Federal Funds Rate497

Other Money Market Interest Rates498

Free Reserves498

The Federal Reserve and Economic Goals500

The Goal of Controlling Inflation500

The Goal of Full Employment501

The Goal of Sustainable Economic Growth503

Equilibrium in the U.s.Balance of Payments and Protecting the Dollar504

What Policies Should We Pursue to Achieve National and International Economic Goals?505

Monetarist View505

The Credit Availability,or Neo-Keynesian View506

Supply Side Economics508

The Trade-Offs among Economic Goals509

The Limitations of Monetary Policy510

Key Terms and Concepts in This Chapter510

Study Questions510

Problems511

Selected References511

Part Six513

The Roles Played by Governments within the Financial System513

Chapter Twenty-Two The Treasury in the Financial Markets513

The Fiscal Policy Activities of the U.S.Treasury513

Sources of Federal Government Funds514

Federal Government Expenditures515

Recent Tax and Expenditure Legislation516

Effects of Federal Borrowing and Budget Deficits on the Financial System and the Economy516

Effects of the Retirement of Government Debt from a Budget Surplus on the Financial System and the Economy518

Overall Impact of Government Borrowing and Spending521

Management of the Federal Debt522

The Size and Growth of the Public Debt523

The Composition of the Public Debt525

Marketable Public Debt525

Nonmarketable Public Debt525

Investors in U.S.Government Securiies526

A Trend toward Shorter Maturities527

Methods of Offering Treasury Securities528

The Goals of Federal Debt Management531

The Impact of Federal Debt Management on the Financial Markets and the Economy532

Summary533

Key Terms and Concepts in This Chapter533

Study Questions534

Problems534

Selected References535

Chapter Twenty-Three State and Local Governments in the Financial Markets536

Growth of State and Local Government Borrowing537

Sources of Revenue for State and Local Governments538

State and Local Government Expenditures539

Motivations for State and Local Government Borrowing540

Types of Securities lssued by State and Local Governments540

Short-Term Securities541

Long-Term Securities541

Types of Revenue Bonds542

Innovations in Municipal Securities543

Key Features of Municipal Debt544

Tax Exemption544

Exemption Contributes to Market Volatility546

Credit ratings546

Seriali=ation548

How Municipal Bonds Are Marketed549

Problems in the Municipal Market550

Problems and Proposals Regarding Tax Exemption550

California's Proposition 13 and Taxpayer Resistance550

The Outlook for State and Local Governments550

Key Terms and Concepts in This Chapter551

Study Questions551

Problems552

Selected References552

Part seven The Consumer in the Financial Markets553

Chapter Twenty-Four Consumer Lending and Borrowing553

Consumers as Lenders of Funds553

FinanciaI Assets Purchased by Consumers554

The Growing Menu of Sarings Instruments Available to Consumers555

Consumers as Borrowers of Funds557

Is Consumer Borrowing Excessive?558

Categories of Consumer Borrowing559

Home Equity Loans560

Credit and Debit Cards561

Credit Cards561

Debit Cards561

The Determinants of Consumer Borrowing562

Consumer Lending Institutions563

Commercial Banks563

Finance Companies563

Other Consumer Lending Institutions564

Factors Considered in Making Consumer Loans564

Financial Disclosure and Consumer Credit565

Truth in Lending565

Fair Credit Billing Act567

Fair Credit Reporting Act567

Consumer Leasing Act568

Competitive Banking Equality Act568

Truth in Savings Act568

Credit Discrimination Laws568

Community Reinvestment Act and Financial Institutions Reform, Recovery and Enforcement Act568

Equal Credit Opportunity ACt569

Fair Housing and Home Mortgage Disclosure Act569

Consumer Bankruptcy Laws569

Summary570

Key Terms and Concepts in This Chapter571

Study Questions571

Problems572

Selected References573

Chapter Twenty-Five The Residential Mortgage Market574

Recent Trends in New Home Prices and the Terms of Mortgage Loans575

The Structure of the Mortgage Market576

Volume Of Mortgage Loans576

Residential versus Nonresidential Mortgage Loans576

Mortgage-Lending Institutions577

The Roles Played by Financial Institutions in the Mortgage Market577

Savings and Loan Associations578

Commercial Banks579

Life Insurance Companies579

Savings Banks579

Mortgage Bankers579

Government Activity580

The Impact of the Great Depression on Government Involvement in the Mortgage Market580

The Creation of Fannie Mae (FNMA)581

The Creation of Ginnie Mae (GNMA)581

The Federal Home Loan Mortgage Corporation(FHLMC581

Innovations in Mortgage Instruments582

Variable-Rate and Other Adjustable Mortgages583

Convertible Mortgages583

Canadian Rollover and Other Renegotiated Mortgage Loans584

Reverse-Annuity Mortgages584

Graduated-Payment Mortgages584

Epilogue on the Fixed-Rate Mortgage585

Creative Financing Techniques585

Second Mortgages585

Home-Leasing Plans585

Land-Leasing Plans and Property Exchanges585

Refinancing Home Mortgages and Home Equity Loans586

Summary586

Key Terms and Concepts in This Chapter587

Study Questions587

Selected References588

Part Eight Businesses in the Financial Markets589

Chapter Twenty-Six Business Borrowing589

Factors Affecting Business Activity in the Money and Capital Markets589

Characteristics of Corporate Notes and Bonds590

PrinciPal Features of CorPorate Notes and Bonds591

Term Bonds versus Serial Bonds591

Recent Trends in Original Maturities of Bonds591

Call Privileges592

Sinking Fund Provisions592

Yields and Costs Of CorPorate Bonds592

The Most Common Types of Corporate Bonds593

New Types of Corporate Notes and Bonds595

Investors in Corporate Notes and Bonds596

The Secondary Market for Corporate Bonds597

The Marketing of Corporate Notes and Bonds598

The Public Sale of Bonds598

Private Placements of Corporate Bonds599

The Volume of Borrowing in the Corporate Bond Market601

Bank Loans to Business Firms602

The Prime, or Base, Interest Rate603

Commercial Mortgages604

Summary605

Key Terms and Concepts in This Chapter606

Study Questions607

Problems607

Selected References608

Chapter Twenty-Seven609

Corporate Stock609

Characteristics of Corporate Stock610

Common Stock610

Preferred Stock611

Stock Market Investors612

Characteristics of the Corporate Stock Market613

The Major Organized Exchanges614

The Informal Over-the-Counter Market616

The Third Market: Trading in Listed Securities off the Exchange617

The Market for Stock Options617

Call Options617

Puts618

Straddles618

The Growth of Options Markets618

The Rise of Program Trading:Portfolio Insurance and Stock Index Arbitraging619

The Development of a Unified International Market for Stock620

Random Walk and Efficient Markets625

Summary626

Key Terms and Concepts in This Chapter627

Study Questions627

Selected References627

Part Nine The International Financial System and the Future629

Chapter Twenty-Eight International Transactions and Currency Values629

The Balance of Payments630

The U.s.Balance of Imernational Payments630

The Current Aecoum631

The Capital Aecoum634

The Basic Balance634

Official Reserve Transactions635

Disequilibrium in the Balance of Payments635

The Problem of Different Monetary Units in International Trade and Finance636

The Gold Standard636

The Gold Exchange Standard637

The Modified Exchange Standard637

Adoption of a New Managed Floating Currency Bank637

Standard638

Determining Foreign Currency Values in Today's Markets639

Essential Features of the Foreign Exchange Market640

Exchange Rate Quotations640

Factors Affecting Foreign Exchange Rates641

Supply and Demand for Foreign Exchange643

The Forward Market for Currencies645

Methods of Quoting Forward Exchange Rates645

Functions of the Forward Exchange Market646

Commercial Covering647

Hedging an Investment Position647

Speculation on Future Currency Prices647

Covered Interest Arbitrage648

The Principle of Interest Rate Party648

The Market for Foreign Currency Futures649

Other Innovative Methods for Dealing with Currency Risk650

Government Intervention in the Foreign Exchange Markets652

Key Terms and Concepts in This Chapter653

Study Questions653

Problems654

Selected References655

Chapter Twenty-Nine International Banking656

The Scope of International Banking Activities657

Multinational Banking Corporations657

Types of Facilities Operated by Banks Abroad657

Services Offered by Intemational Banks658

Issuing Letters of Credit658

Buying and Selling Foreign Exchange(FORFX)658

Issuing Bankers'Acceptances658

Accepting Eurocurrency Deposits and Making Eurocurrency Loans658

Marketing and Underwriting of Both Domestic and Eurocurrency Bonds,Notes,and Equity Shares659

Securitizing Loans659

Other Services Provided by International Banks660

Foreign Banks in the United States660

Recent Growth of Foreign Banks in the United States660

Federal Regulation of Foreign Bank Activity661

Regulation of the International Banking Activities of U.S. Banks662

The Future of International Banking664

The Risks of International Lending664

Public Confidence and Bank failures665

The SPread of Deregulation:how Fast should We Go?666

Prospects and Issues in the l990s667

Key Terms and Concepts in This Chapter668

Study Questions668

Selected References668

Chapter Thirty The Future or the Financial System669

Social,Economic,and Demographic Forces and Trends Reshaping the Financial System670

The Challenges and Opportunities Presented by Recent Trends672

Dealing with Risk in the Financial System:Ensuring the Strength and Viability of Financial Institutions672

The Implications of Inflation for Financial Institutions675

The Effect of New Technology on the Design and Delivery of Financial Services676

The Changing Mix of Financial Service Suppliers679

Management Coordination within Diversified Financial Institutions681

Steps Toward Better Management Coordination681

The Future Of Alternative Financial Service Distribution Systems682

The Future Need for Regulation of Financial Institutions682

Regulations That Could Grow685

Summary and a Look Forward686

Key Terms and Concepts in This Chapter686

Study Questions687

Selected References687

Appendix: Present Value, Annuity,Compound lnterest, and Annual Percentage Rate(APR)Tables688

Money and Capital Markets Dictionary697

Index710

Contents in Brief1

Part One1

The Financial System in Perspective1

Chapter One1

The Role of the FinanciaI System in theGlobal Economy1

Chapter Two23

Financial Assets, Money, and Financial Transactions23

Chapter Three44

Sources of Information for Financial Decision Making in the Money and Capital Markets44

Chapter Four82

The Commercial Banking Industry82

Chapter Five109

Nonbank Thrift Institutions: Credit Unions, Savings and Loan Associations, Savings Banks, and Money Market Mutual Funds109

Chapter Six132

Insurance Companies, Pension Funds, and Other Financial Institutions132

Chapter Seven164

The Regulation of Financial Institutions164

Chapter Eight192

Interest Rates in the Financial System192

Chapter Nine219

Relationships between Interest Rates and Security Prices219

Chapter Ten239

Inflation, Yield Curves, and Duration239

Chapter Eleven273

Default Risk, Taxes, and Other Factors Affecting Interest Rates273

Chapter Twelve299

Interest Rate Forecasting and Hedging against Interest Rate Risk299

Chapter Thirteen323

FinanciaI Futures and Options Contracts323

Part Four356

The Money Market Chapter Fourteen Characteristics of the Money Market356

Chapter Fifteen369

Treasury Bills, Dealer Loans, and Repurchase Agreements369

Chapter Sixteen389

Federal Funds, Negotiable CDs, and Loans from the Discount Window389

Chapter Seventeen407

Commercial Paper and Federal Agenc Securities407

Chapter Eighteen426

International Money Market Instruments:Bankers' Acceptances and Eurodollars426

Chapter Nineteen443

Central Banking and the Role of the Federal Reserve443

Chapter Twenty463

The Tools of Monetary Policy463

Chapter Twenty-one487

Indicators and Goals of Monetary Policy487

Chapter Twenty-Two513

The Treasury in the Financial Markets513

Chapter Twenty-Three536

State and Local Governments in the Financial Markets536

Chapter Twenty-Four553

Consumer Lending and Borrowing553

Chapter Twenty-Five574

The Residential Mortgage Market574

Chapter Twenty-Six589

Business Borrowing589

' Chapter Twenty-Seven609

Corporate Stock609

Chapter Twenty-Eight629

International Transactions and Currency Values629

Chapter Twenty-Nine656

International Banking656

Chapter Thirty669

The Future of the Financial System669

Appendix: Present Value, Annuity,Compound Interest, and Annual Percentage Rate(APR)Tables688

Money and Capital Markets Dictionary697

Index710