Money and Capital Markets - The Money Market versus the Capital Market 12 Divisions of the Money and

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Transcript of Money and Capital Markets - The Money Market versus the Capital Market 12 Divisions of the Money and

  • Money and Capital Markets

    Financial Institutions and Instruments in a Global Marketplace

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  • Contents

    PART1

    The Global Financial System in Perspective 1

    1 Functions and Roles of the Financial System in the Economy 2

    1.1 Introduction to the Financial System 3

    1.2 The Global Economy and the Financial System 3 Flows within the Global Economic System 3 The Role of Markets in the Global Economic System 4 Types of Markets 5 The Financial Markets and the Financial System: Channel for Savings and Investment 5 Nature of Savings 6 Nature of Investment 6

    1.3 Economic Functions Performed by the Global Financial System and the Financial Markets 7 Savings Function 7 Wealth Function 8 Liquidity Function 9 Credit Function 9 Payments Function 9 Risk Protection Function 10 Policy Function 11

    1.4 Types of Financial Markets within the Global Financial System 11 The Money Market versus the Capital Market 12 Divisions of the Money and Capital Markets 12 Open versus Negotiated Markets 14

    Primary versus Secondary Markets 14 Spot versus Futures, Forward, and Option Markets 14

    1.5 Factors Tying All Financial Markets Together 15 Credit, the Common Commodity 16 Speculation and Arbitrage 16

    1.6 The Dynamic Financial System 16

    1.7 The Plan of This Book 17 Summary of the Chapter's Main Points 19 Key Terms Appearing in This Chapter 20 Problems and Issues 20 Web-Based Problems 22 Selected References to Explore 23

    Financial Assets, Money, Financial Transactions, and Financial Institutions 25 2.1 Introduction: The Role of Financial

    Assets 26 2.2 The Nature and Characteristics of

    Financial Assets 26 Characteristics of Financial Assets 26 Types of Financial Assets 27

    2.3 How Financial Assets Are Created 27

    2.4 Financial Assets and the Financial System 31

    2.5 Lending and Borrowing in the Financial System 33

    2.6 Money as a Financial Asset 36 What Is Money? 36 The Functions of Money 37 The Value of Money and Other Financial Assets and Inflation 38

    xxii

  • Contents

    2.7 The Evolution of Financial Transactions 40 Direct Finance 40 Semidirect Finance 41 Indirect Finarite and-Financial Intermediation 42

    2.8 Relative Sizes and Types of Major Financial Institutions 44 Comparative Sizes of Key Financial- Service Providers 44 Classifying Financial Institutions 45 Portfolio (Financial-Asset) Decisions by Financial Institutions 46

    2.9 The Disintermediation of Funds 47 New Types of Disintermediation 47

    2.10 Bank-Dominated versus Market- Dominated Financial Systems 48 Summary of the Chapter's Main Points 49 Key Terms Appearing in This Chapter 50 Problems and Issues 51 Web-Based Problems 53 Selected References to Explore 53

    The Financial Information Marketplace 55 3.1 Introduction: The Importance

    of Information in the Financial Marketplace 56

    3.2 The Great Debate over Efficient Markets and Asymmetric Information 56 The Efficient Markets Hypothesis (EMH) 57 What Is an Efficient Market? 57 Different Forms of the EMH 58 Insiders and Insider Trading 59 What Is Insider Trading ? 59 When Is Insider Trading Legal or Illegal? 59 The Asymmetric Information Hypothesis (AIH) 60 Problems Asymmetries Can Create: Lemons and Plums 61 Problems Asymmetries Can Create: Adverse Selection 62

    Problems Asymmetries Can Create: Moral Hazard 63 Asymmetry, Efficiency, and Real- World Markets 64 Informational Asymmetries and the Law 65

    3.3 Debt Security Prices and Yields: Sources of Information 68 Bonds and Notes 68 Bid and Asked Prices and Pricing Information 68

    3.4 Stock Prices and Dividend Yields: Sources of Information 69 Price and Yield Information 70 Stock Price Indexes and Foreign Stock Prices 70

    3.5 Information on Security Issuers 71 Moody's and Standard & Poor's Reports 71 Securities and Exchange Commission (SEC) Reports 72 Company Histories 72 Dun & Bradstreet Ratings and Risk Management 72 Financial Institutions 73

    Credit Bureaus 73 3.6 General Economic and Financial

    Conditions 73 The Federal Reserve System 73 Other Domestic and International Sources of Information 74 Summary of the Chapter's Main Points 75 Key Terms Appearing in This Chapter 76 Problems and Issues 76 Web-Based Problems 78 Selected References to Explore 79 Appendix 3A: The Flow of Funds in the Financial System 80

    The Future of the Financial System and Trends in the Money and Capital Markets 88 4.1 Introduction: The Financial

    Markets in Change 89

  • xxiv Contents

    4.2 Financial Forces Reshaping the Money and Capital Markets Today 89

    4.3 Economic and Demographic Forces Reshaping the Financial System 91

    4.4 The Challenges and Opportunities Presented by Recent Trends 94 Dealing with Risk in the Financial System: Ensuring the Strength of Financial Institutions and Increasing Public Confidence 95

    The Consequences of Reduced Public Confidence 95

    Ways to Promote Public Confidence in Financial Institutions and Reduce Risk in the Financial System 95

    Developing Better Management Tools to Deal with Risk 97

    The Information Problem 98

    The Effect of New Technology on the Design and Delivery of Financial Services 99 The Information Revolution 99 Recent Technological Advances 99 Public Attitudes and Cost 100 The Changing Mix of Financial-Service Suppliers in the Financial System . 101 Price Sensitivity and Local Competition 101 Importance of Established Delivery Systems 101 New Financial Institutions and Instruments 101 Securitization 102 Consolidations and Convergences within the Financial System 102

    4.5 A New Role for Regulation in an Age of Financial- Services: Consolidation and Convergence 104

    4.6 The Payments System: Current and Future 107

    4.7 The Current and Future Need for Regulation of Financial Institutions 108 Financial Service Regulations That Could Grow 109

    Financial Disclosure 109

    Privacy Protection and Identity Theft 110

    Social Responsibility 111

    Promoting a Level Playing Field 111

    Summary of the Chapter's Main Points 112 Key Terms Appearing in This Chapter 113 Problems and Issues 113 Web-B ased Problems 114 Selected References to Explore 115

    PART 2

    Interest Rates and the Prices of Financial Assets 117

    5 The Determinants of Interest Rates: Competing Ideas 118 5.1 Introduction: Interest Rates and the

    Price of Credit 119 5.2 Functions of the Rate of Interest in

    the Economy 119 5.3 The Classical Theory of Interest

    Rates 120 Saving by Households 120 Saving by Business Firms 121 Saving by Government 122 The Demand for Investment Funds 122 The Investment Decision-Making Process 122 Investment Demand and the Rate of Interest 124 The Equilibrium Rate of Interest in the Classical Theory of Interest 124 Limitations of the Classical Theory of Interest 125

    5.4 The Liquidity Preference or Cash Balances Theory of Interest Rates 126 The Demand for Liquidity 126 Motives for Holding Money (Cash Balances) 127 Total Demand for Money (Cash Balances) 128

  • Contents xxv

    The Supply of Money (Cash Balances) 130 The Equilibrium Rate of Interest in Liquidity Preference Theory 130 Limitations of the Liquidity Preference Theory 131

    5.5 The Loanable Funds Theory of Interest 132 The Demand for Loanable Funds 132 Consumer (Household) Demand for Loanable Funds 132 Domestic Business Demand for Loanable Funds 132 Government Demand for Loanable Funds 132 Foreign Demand for Loanable Funds 132 Total Demand for Loanable Funds 133 The Supply of Loanable Funds 133 Domestic Saving 133 Dishoarding of Money Balances 134 Creation of Credit by the Domestic Banking System 134 Foreign Lending to the Domestic Funds Market 134 Total Supply of Loanable Funds 135 The Equilibrium Rate of Interest in the Loanable Funds Theory 135

    5.6 The Rational Expectations Theory of Interest 137 Summary of the Chapter's Main Points 141 Key Terms Appearing in This Chapter 142 Problems and Issues 142 Web-Based Problems 144 Selected References to Explore 145

    Measuring and Calculating Interest Rates and Financial Asset Prices 147 6.1 Introduction to Interest Rates and

    Asset Prices 148 6.2 Units of Measurement for Interest

    Rates 148 Calculating and Quoting Interest Rates 148 Basis Points 148

    6.3 Interest Rates in the Wholesale Money Markets 149 Computing Interest Rates on Money Market Assets That Are Sold at a Discount 149 Holding-Period Yield on Money Market Assets Sold at a Discount 150 Interest Rate Quotations on U.S. Treasury Bills 151

    6.4 Interest Rates on Bonds and Other Long-Term Debt Securities 152 Yield to Maturity (YTM) 152 Holding-Period Yield on Bonds and Other Long-Term Debt Securities 153 Understanding the Concepts of Yield to Maturity and Holding-Period Yield 154

    Price Quotations on U.S. Treasury Notes and Bonds 155 Price Quotations on Corporate Bonds 156

    6.5 Interest Rates and the Prices of Debt Securities 157

    6.6 Rates of Return on a Perpetual Financial Instrument 160 The Rate of Return on Fixed-Income Perpetuities 160 Interest Rates and Stock Prices 161 Calculating the Holding-Period Yield on Stock 162 Price Quotations in Corporate Stock 162

    6.7 Interest Rates Charged by Institutional Lenders 164 The Simple Interest Method 164 Add-On Rate of Interest 165 Discount Loan Method 165 Home Mortgage Interest Rate 165 Annual Percentage Rate (APR) 167 Compound Interest 168 The Annual Percentage Yield (APY) on Deposits 169 Summary of the Chapter's Main Points 170 Key Terms Appearing in This Chapter 171 Problems and Issu