Financial Markets and Institutions (2017/2018) Global Edition PDF

GLOBAL GLOBAL EDITION EDI...

GLOBAL GLOBAL EDITION EDITION For these Global Editions, the editorial team at Pearson has collaborated with educators across the world to address a wide Financial Markets and Institutions range of subjects and requirements, equipping students with the best possible learning tools. This Global Edition preserves the cutting-edge approach and pedagogy of the original, but also features alterations, customization, and adaptation from the North American version. Financial Markets and Institutions EDITION NINTH NINTH EDITION Eakins Mishkin This is a special edition of an established title widely used by colleges and universities throughout the world. Pearson published this exclusive edition for the benefit Frederic S. Mishkin Stanley G. Eakins of students outside the United States and Canada. If you purchased this book within the United States or Canada, EDITION GLOBAL you should be aware that it has been imported without the approval of the Publisher or Author. Pearson Global Edition Mishkin_09_1292215003_Final.indd 1 08/11/17 3:21 PM  FINANCIAL MARKETS AND INSTITUTIONS Ninth Edition Global Edition Frederic S. Mishkin Graduate School of Business, Columbia University Stanley G. Eakins East Carolina University Harlow, England London New York Boston San Francisco Toronto Sydney Dubai Singapore Hong Kong Tokyo Seoul Taipei New Delhi Cape Town Sao Paulo Mexico City Madrid Amsterdam Munich Paris Milan A01_MISH5006_09_GE_FM.indd 1 07/11/17 12:10 PM  The Pearson Series in Finance Berk/DeMarzo Gitman/Zutter McDonald Corporate Finance*† Principles of Managerial Finance*† Derivatives Markets Corporate Finance: The Core*† Principles of Managerial Finance––Brief Fundamentals of Derivatives Markets Edition*† Berk/DeMarzo/Harford Mishkin/Eakins Fundamentals of Corporate Finance*† Haugen Financial Markets and Institutions† The Inefficient Stock Market: What Pays Brooks Off and Why Moffett/Stonehill/Eiteman Financial Management: The New Finance: Overreaction, Fundamentals of Multinational Finance† Core Concepts*† Complexity, and Uniqueness Pennacchi Copeland/Weston/Shastri Holden Theory of Asset Pricing Financial Theory and Corporate Excel Modeling in Corporate Finance† Policy Excel Modeling in Investments Rejda/McNamara Principles of Risk Management and Dorfman/Cather Hughes/MacDonald Insurance† Introduction to Risk Management and International Banking: Text and Cases Insurance Smart/Gitman/Joehnk Hull Fundamentals of Investing*† Eakins/McNally Fundamentals of Futures and Options Corporate Finance Online* Markets† Solnik/McLeavey Options, Futures, and Other Global Investments Eiteman/Stonehill/Moffett Derivatives† Multinational Business Finance † Titman/Keown/Martin Keown Financial Management: Principles and Fabozzi Personal Finance: Turning Money into Applications*† Bond Markets: Analysis and Wealth* Strategies† Titman/Martin Keown/Martin/Petty Valuation: The Art and Science of Foerster Foundations of Finance: The Logic and Corporate Investment Decisions Financial Management: Concepts and Practice of Financial Management*† Applications*† Weston/Mitchel/Mulherin Madura Takeovers, Restructuring, and Corporate Frasca Personal Finance* Governance Personal Finance *denotes Pearson MyLab Finance titles     Log onto www.myfinancelab.com to learn more. † denotes availability of Global Edition titles A01_MISH5006_09_GE_FM.indd 2 07/11/17 2:26 PM  Vice President, Business Publishing: Donna Battista Operations Specialist: Carol Melville Director of Portfolio Management: Adrienne D’Ambrosio Content Producer, Global Edition: Purnima Narayanan Senior Portfolio Manager: Christina Masturzo Senior Manufacturing Controller, Global Edition: Kay Holman Associate Acquisitions Editor, Global Edition: Creative Director: Blair Brown Ananya Srivastava Manager, Learning Tools: Brian Surette Associate Project Editor, Global Edition: Paromita Banerjee Content Developer, Learning Tools: Lindsey Sloan Vice President, Product Marketing: Roxanne McCarley Managing Producer, Digital Studio, Arts and Business: Director of Strategic Marketing: Brad Parkins Diane Lombardo Strategic Marketing Manager: Deborah Strickland Digital Studio Producer: Melissa Honig Product Marketer: Tricia Murphy Digital Studio Producer: Alana Coles Field Marketing Manager: Ramona Elmer Digital Content Team Lead: Noel Lotz Field Marketing Assistant: Kristen Compton Manager, Media Production, Global Edition: Vikram Kumar Product Marketing Assistant: Jessica Quazza Full-Service Project Management and Composition: Vice President, Production and Digital Studio, Arts and Cenveo® Publisher Services Business: Etain O’Dea Interior Design: Cenveo® Publisher Services Director of Production, Business: Jeff Holcomb Cover Design: Lumina Datamatics Services Managing Producer, Business: Alison Kalil Cover Art: dominic8 / Shutterstock Content Producer: Kathryn Brightney Microsoft and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published as part of the services for any purpose. 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Eakins, to be identified as the authors of this work, have been asserted by them in accordance with the Copyright, Designs and Patents Act 1988. Authorized adaptation from the United States edition, entitled Financial Markets and Institutions, 9th Edition, ISBN 978-0-13-451926-5 by Frederic S. Mishkin and Stanley G. Eakins, published by Pearson Education © 2018. A01_MISH5006_09_GE_FM.indd 3 10/11/17 1:28 pm  Copyright © 2018, 2015, 2012 by Frederic S. Mishkin. All rights reserved. No part of this publication may be repro- duced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without either the prior written permission of the publisher or a license permitting restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd, Saffron House, 6–10 Kirby Street, London EC1N 8TS. All trademarks used herein are the property of their respective owners. The use of any trademark in this text does not vest in the author or publisher any trademark ownership rights in such trademarks, nor does the use of such trademarks imply any affiliation with or endorsement of this book by such owners. For information regarding permissions, request forms, and the appropriate contacts within the Pearson Education Global Rights and Permissions department, please visit www.pearsoned.com/permissions/. ISBN 10: 1-292-21500-3 ISBN 13: 978-1-292-21500-6 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library 10 9 8 7 6 5 4 3 2 1 Typeset in Times NR MT Pro by Cenveo® Publisher Services Printed and bound by Vivar in Malaysia A01_MISH5006_09_GE_FM.indd 4 10/11/17 1:10 pm  To My Dad —F. S. M. To My Wife, Laurie —S. G. E. A01_MISH5006_09_GE_FM.indd 5 07/11/17 12:10 PM  This page intentionally left blank A01_MISH4182_11_GE_FM.indd 6 10/06/15 11:46 am  Contents in Brief Contents in Detail 9 Contents on the Web 27 Preface 31 About the Authors 39 PART ONE INTRODUCTION 41 1 Why Study Financial Markets and Institutions? 41 2 Overview of the Financial System 55 PART TWO FUNDAMENTALS OF FINANCIAL MARKETS 77 3 What Do Interest Rates Mean and What Is Their Role in Valuation? 77 4 Why Do Interest Rates Change? 106 5 How Do Risk and Term Structure Affect Interest Rates? 129 6 Are Financial Markets Efficient? 157 PART THREE FUNDAMENTALS OF FINANCIAL INSTITUTIONS 175 7 Why Do Financial Institutions Exist? 175 8 Why Do Financial Crises Occur and Why Are They So Damaging to the Economy? 206 PART FOUR CENTRAL BANKING AND THE CONDUCT OF MONETARY POLICY 225 9 Central Banks 225 10 Conduct of Monetary Policy 244 PART FIVE FINANCIAL MARKETS 285 11 The Money Markets 285 12 The Bond Market 308 13 The Stock Market 333 14 The Mortgage Markets 354 15 The Foreign Exchange Market 375 16 The International Financial System 403 PART SIX THE FINANCIAL INSTITUTIONS INDUSTRY 425 17 Banking and the Management of Financial Institutions 425 18 Financial Regulation 451 19 Banking Industry: Structure and Competition 479 20 The Mutual Fund Industry 515 7 A01_MISH5006_09_GE_FM.indd 7 07/11/17 12:10 PM  8 Contents in Brief 21 Insurance Companies and Pension Funds 540 22 Investment Banks, Security Brokers and Dealers, and Venture Capital Firms 570 PART SEVEN THE MANAGEMENT OF FINANCIAL INSTITUTIONS 594 23 Risk Management in Financial Institutions 594 24 Hedging with Financial Derivatives 615 Glossary 649 Index 667 CHAPTERS ON THE WEB 25 Financial Crises in Emerging Market Economies W-1 26 Savings Associations and Credit Unions W-22 27 Finance Companies W-49 A01_MISH5006_09_GE_FM.indd 8 07/11/17 12:10 PM  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 9 A01_MISH5006_09_GE_FM.indd 9 07/11/17 12:10 PM  10 Contents in Detail 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 A01_MISH5006_09_GE_FM.indd 10 07/11/17 12:10 PM  Contents in Detail 11 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 A01_MISH5006_09_GE_FM.indd 11 07/11/17 12:10 PM  12 Contents in Detail 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 A01_MISH5006_09_GE_FM.indd 12 07/11/17 12:10 PM  Contents in Detail 13 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 A01_MISH5006_09_GE_FM.indd 13 07/11/17 12:10 PM  14 Contents in Detail 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 A01_MISH5006_09_GE_FM.indd 14 10/11/17 1:10 pm  Contents in Detail 15 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 A01_MISH5006_09_GE_FM.indd 15 07/11/17 12:10 PM  16 Contents in Detail 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 A01_MISH5006_09_GE_FM.indd 16 07/11/17 12:10 PM  Contents in Detail 17 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 A01_MISH5006_09_GE_FM.indd 17 07/11/17 12:10 PM  18 Contents in Detail 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 A01_MISH5006_09_GE_FM.indd 18 07/11/17 12:10 PM  Contents in Detail 19 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 A01_MISH5006_09_GE_FM.indd 19 07/11/17 12:10 PM  20 Contents in Detail 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 A01_MISH5006_09_GE_FM.indd 20 07/11/17 12:10 PM  Contents in Detail 21 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 A01_MISH5006_09_GE_FM.indd 21 07/11/17 12:10 PM  22 Contents in Detail 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 A01_MISH5006_09_GE_FM.indd 22 07/11/17 12:10 PM  Contents in Detail 23 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