Foundations of Global Financial Markets and Institutions

by Fabozzi, Jones

ISBN: 9780262039543 | Copyright 0

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A thoroughly revised and updated edition of a textbook for graduate students in finance, with new coverage of global financial institutions.

This thoroughly revised and updated edition of a widely used textbook for graduate students in finance now provides expanded coverage of global financial institutions, with detailed comparisons of U.S. systems with non-U.S. systems. A focus on the actual practices of financial institutions prepares students for real-world problems.

After an introduction to financial markets and market participants, including asset management firms, credit rating agencies, and investment banking firms, the book covers risks and asset pricing, with a new overview of risk; the structure of interest rates and interest rate and credit risks; the fundamentals of primary and secondary markets; government debt markets, with new material on non-U.S. sovereign debt markets; corporate funding markets, with new coverage of small and medium enterprises and entrepreneurial ventures; residential and commercial real estate markets; collective investment vehicles, in a chapter new to this edition; and financial derivatives, including financial futures and options, interest rate derivatives, foreign exchange derivatives, and credit risk transfer vehicles such as credit default swaps. Each chapter begins with learning objectives and ends with bullet point takeaways and questions.

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Contents (pg. vii)
Preface (pg. xi)
Acknowledgments (pg. xiii)
Overview of the Book (pg. xv)
Part I: Financial Markets and Players (pg. xv)
Part II: Understanding Risks and Asset Pricing (pg. xv)
Part III: Interest Rates, Interest Rate Risk, and Credit Risk (pg. xvi)
Part IV: Primary and Secondary Markets (pg. xvii)
Part V: Global Government Debt Markets (pg. xvii)
Part VI: Corporate Funding Markets (pg. xvii)
Part VII: Real Estate Markets (pg. xviii)
Part VIII: Collective Investment Vehicles and Financial Derivatives Markets (pg. xviii)
I. Financial Markets and Players (pg. 1)
1. Introduction (pg. 3)
Contents (pg. 3)
Learning Objectives (pg. 3)
Financial Assets (pg. 5)
Financial Markets (pg. 9)
Globalization of Financial Markets (pg. 11)
Asset Classes (pg. 13)
Derivatives Markets (pg. 14)
Financial Markets and the Real Economy (pg. 17)
Key Points (pg. 18)
Questions (pg. 20)
2. Role of Governments in Financial Markets (pg. 23)
Contents (pg. 23)
Learning Objectives (pg. 24)
Macroprudential versus Microprudential Government Policies (pg. 25)
Regulation of Financial Markets (pg. 25)
Governments as Financial Intermediaries (pg. 28)
Government Influence on Financial Markets through the Actions of the Central Bank (pg. 30)
Government Bailouts (pg. 32)
Financial Regulators Outside the United States (pg. 37)
Other International Participants (pg. 38)
Views on the Degree of Government Intervention in Financial Markets (pg. 40)
Key Points (pg. 42)
Questions (pg. 43)
3. Financial Institutions, Financial Intermediaries, and Asset Management Firms (pg. 47)
Contents (pg. 47)
Learning Objectives (pg. 47)
Financial Institutions (pg. 48)
Role of Financial Intermediaries (pg. 49)
Overview of Asset/Liability Management for Financial Institutions (pg. 52)
Asset Management Firms (pg. 57)
Key Points (pg. 58)
Questions (pg. 59)
4. Overview of Private Market Participants (pg. 61)
Contents (pg. 61)
Learning Objectives (pg. 62)
Households (pg. 62)
Nonfinancial Corporations (pg. 63)
Depository Institutions (pg. 64)
Insurance Companies (pg. 64)
Investment Companies (pg. 65)
Private Pension Funds (pg. 65)
Nonprofit Organizations (pg. 68)
Foreign Investors (pg. 69)
Key Points (pg. 71)
Questions (pg. 72)
Appendix: U.S. Pension Regulations and Issues (pg. 73)
5. Credit Rating Agencies and Their Role in Financial Markets (pg. 81)
Contents (pg. 81)
Learning Objectives (pg. 81)
The Role of CRAs in the Financial System (pg. 82)
CRAs and Nationally Recognized Statistical Rating Organizations in the United States (pg. 83)
European Regulation of CRAs (pg. 84)
Credit Rating Systems (pg. 85)
Use of Ratings by Regulators (pg. 87)
Nonregulatory Use of Ratings (pg. 88)
Concerns Regarding CRAs (pg. 89)
Factors Considered When Assigning Ratings (pg. 92)
Key Points (pg. 95)
Questions (pg. 97)
6. Depository Institutions: Activities and Characteristics (pg. 99)
Contents (pg. 99)
Learning Objectives (pg. 100)
Regulators of U.S. Banks (pg. 101)
Bank Regulation (pg. 105)
Bank Activities (pg. 110)
Bank Funding (pg. 112)
Nonbank Depository Institutions: Thrifts (pg. 114)
Shadow Banking (pg. 116)
Key Points (pg. 119)
Questions (pg. 122)
Appendix: The S&L Crisis (pg. 124)
7. Central Banks (pg. 127)
Contents (pg. 127)
Learning Objectives (pg. 128)
Central Banks and Their Purpose (pg. 129)
The Central Bank of the United States: The Federal Reserve System (pg. 131)
The Fed and the Supply of Money (pg. 132)
Goals of Monetary Policy (pg. 142)
Global Central Banks (pg. 147)
Key Points (pg. 149)
Questions (pg. 150)
8. Insurance Companies (pg. 153)
Contents (pg. 153)
Learning Objectives (pg. 154)
Types of Insurance (pg. 155)
Fundamentals of the Insurance Industry (pg. 157)
Structure of Insurance Companies (pg. 159)
Types of Life Insurance Policies (pg. 162)
Regulation of Insurance Companies (pg. 168)
Catastrophic Risk and Its Management (pg. 174)
Insurance Company Investment Strategies (pg. 176)
Insurance Company Expansion into Other Financial Services (pg. 177)
Insurance-Based Investment Banking (pg. 180)
Key Points (pg. 181)
Questions (pg. 182)
9. Investment Banking Firms (pg. 185)
Contents (pg. 185)
Learning Objectives (pg. 185)
Investment Banking Industry (pg. 187)
Public Offering of Securities (pg. 188)
Private Placement of Securities (pg. 191)
Securitization of Assets (pg. 191)
Mergers and Acquisitions (pg. 192)
Merchant Banking (pg. 193)
Advising on Financial Restructuring (pg. 193)
Trading of Securities (pg. 194)
Prime Brokerage (pg. 201)
Trading and Creation of Derivative Instruments (pg. 201)
Asset Management (pg. 202)
Key Points (pg. 202)
Questions (pg. 204)
II. Understanding Risks and Asset Pricing (pg. 207)
10. Overview of Risks and Their Management (pg. 209)
Contents (pg. 209)
Learning Objectives (pg. 210)
Defining Risk (pg. 211)
Financial Risk Management (pg. 214)
Investment Risk (pg. 218)
Funding Risk (pg. 225)
Systemic Financial Risk (pg. 229)
Financial Innovation (pg. 230)
Key Points (pg. 231)
Questions (pg. 233)
11. Properties and Pricing of Financial Assets (pg. 239)
Contents (pg. 239)
Learning Objectives (pg. 240)
Properties of Financial Assets (pg. 240)
Principles of Pricing Financial Assets (pg. 246)
Price Volatility of Financial Assets (pg. 250)
Key Points (pg. 259)
Questions (pg. 260)
12. Return Distributions, Risk Measures, and Risk-Return Ratios (pg. 263)
Contents (pg. 263)
Learning Objectives (pg. 264)
Measuring the Rate of Return (pg. 265)
Return Distributions (pg. 265)
Joint Probability Distributions (pg. 279)
Portfolio Risk Measures (pg. 281)
Reward-Risk Ratios (pg. 284)
Key Points (pg. 286)
Questions (pg. 289)
13. Portfolio Selection Theory (pg. 295)
Contents (pg. 295)
Learning Objectives (pg. 295)
The Concept of Portfolio Diversification (pg. 297)
Markowitz Portfolio Theory (pg. 298)
The Role of Correlation in Determining Portfolio Risk and the Diversification Effect (pg. 300)
Constructing Portfolios (pg. 302)
Selecting the Optimal Portfolio (pg. 305)
Criticisms of Portfolio Theory (pg. 308)
Key Points (pg. 312)
Questions (pg. 313)
14. Asset Pricing Theories (pg. 317)
Contents (pg. 317)
Learning Objectives (pg. 318)
Economic Assumptions (pg. 318)
Capital Market Theory (pg. 320)
The Capital Asset Pricing Model (pg. 324)
The Arbitrage Pricing Theory Model (pg. 334)
Factor Models in Practice (pg. 336)
Some Principles to Take Away (pg. 338)
Key Points (pg. 338)
Questions (pg. 340)
III. Interest Rates, Interest Rate Risk, and Credit Risk (pg. 343)
15. The Theory of Interest Rates (pg. 345)
Contents (pg. 345)
Learning Objectives (pg. 346)
Fisher’s Theory of Interest Rates (pg. 347)
The Loanable Funds Theory of Interest Rates (pg. 362)
The Liquidity Preference Theory of Interest Rates (pg. 363)
Böhm-Bawerk’s Positive Theory of Capital (pg. 365)
Efficiency Properties of Markets (pg. 366)
Real and Nominal Interest Rates: Fisher’s Law (pg. 367)
Estimating the Market’s Expected Inflation Rate (pg. 368)
Natural Rate of Interest (pg. 369)
Risk-Free Interest Rate and the Existence of a Safe Asset (pg. 370)
Negative Interest Rates (pg. 371)
Historical Interest Rates in the United States (pg. 372)
Key Points (pg. 374)
Questions (pg. 375)
16. The Structure of Interest Rates (pg. 377)
Contents (pg. 377)
Learning Objectives (pg. 378)
The Structure of Interest Rates (pg. 378)
The Term Structure of Interest Rates (pg. 387)
Key Points (pg. 406)
Questions (pg. 408)
IV. Primary and Secondary Markets (pg. 413)
17. Primary Markets (pg. 415)
Contents (pg. 415)
Learning Objectives (pg. 415)
Regulation of the Primary Market (pg. 416)
Variations in the Underwriting of Securities (pg. 424)
World Capital Markets Integration and Fundraising Implications (pg. 428)
Key Points (pg. 430)
Questions (pg. 431)
18. Secondary Markets (pg. 435)
Contents (pg. 435)
Learning Objectives (pg. 436)
Function of Secondary Markets (pg. 436)
Architectural Structure of Secondary Markets (pg. 437)
Trading Locations (pg. 439)
Theoretically Perfect Market Characteristics (pg. 440)
Role of Brokers and Dealers in Real Markets (pg. 443)
Market Efficiency (pg. 446)
Electronic Trading (pg. 448)
Key Points (pg. 449)
Questions (pg. 450)
19. The Foreign Exchange Market (pg. 453)
Contents (pg. 453)
Learning Objectives (pg. 453)
Foreign Exchange Rates (pg. 454)
FX Turnover (pg. 458)
Market Participants in the FX Market (pg. 459)
FX Risk and Derivative Instruments (pg. 462)
Key Points (pg. 463)
Questions (pg. 463)
V. Global Government Debt Markets (pg. 467)
20. Sovereign Debt Markets (pg. 469)
Contents (pg. 469)
Learning Objectives (pg. 469)
Types of Securities Issued (pg. 472)
Primary Markets for Sovereign Debt (pg. 476)
Secondary Markets (pg. 480)
Sovereign Credit Risk (pg. 484)
Key Points (pg. 486)
Questions (pg. 487)
21. Subnational (Municipal) Government Debt Markets (pg. 491)
Contents (pg. 491)
Learning Objectives (pg. 492)
Central Government Control of Municipal Borrowing (pg. 493)
Structure of a Municipal Credit Market (pg. 494)
Multilateral Financial Institution Arrangements (pg. 496)
Infrastructure Financing via Project Finance and Public-Private Partnerships (pg. 496)
Municipal Green Bond Issuance (pg. 497)
U.S. Municipal Securities Market (pg. 498)
Chinese Municipal Bond Market (pg. 508)
Key Points (pg. 509)
Questions (pg. 511)
VI. Corporate Funding Markets (pg. 513)
22. The Structure and Trading Venues of the Equity Market (pg. 515)
Contents (pg. 515)
Learning Objectives (pg. 516)
Evolution of Stock Markets and Their Institutionalization (pg. 517)
Regulation of U.S. Equity Markets (pg. 520)
Stock Trading Market Structures (pg. 522)
U.S. Equity Trading Venues (pg. 525)
Execution of an Order (pg. 535)
Market Trading Regulation in the United States (pg. 536)
Other Types of Common Stock Trading (pg. 542)
Key Points (pg. 544)
Questions (pg. 549)
23. U.S. Common Stock Market: Pricing Efficiency, Trading, and Investment Strategies (pg. 551)
Contents (pg. 551)
Learning Objectives (pg. 552)
Equity Asset Classes (pg. 553)
Stock Market Indexes (pg. 555)
Pricing Efficiency of the Stock Market (pg. 563)
Common Stock Investment Strategies (pg. 567)
Common Stock Trading Arrangements (pg. 569)
Key Points (pg. 581)
Questions (pg. 584)
24. Non-U. S. Equity Markets (pg. 587)
Contents (pg. 587)
Learning Objectives (pg. 588)
Rationale for Investing Outside the Home Equity Market (pg. 588)
Non-U. S. Equity Markets (pg. 589)
Stock Market Indexes (pg. 591)
Exchange-Provided Indexes (pg. 593)
Non-Exchange Sponsors of International Indexes (pg. 594)
Regulation of the U.K. and European Stock Markets (pg. 595)
Chinese Equity Markets (pg. 596)
Chinese vs U.S. Equity Markets (pg. 607)
Key Points (pg. 607)
Questions (pg. 609)
25. Global Short-Term Funding and Investing Markets (pg. 611)
Contents (pg. 611)
Learning Objectives (pg. 612)
Interbank Funding Market (pg. 613)
Repo Market (pg. 620)
Commercial Paper Market (pg. 625)
Large-Denomination Negotiable Certificates of Deposit (pg. 631)
Banker’s Acceptances (pg. 633)
Money Market Funds (pg. 636)
Key Points (pg. 640)
Questions (pg. 642)
Appendix: Asset-Backed Commercial Paper (pg. 644)
Risks Associated with Investing in ABCP (pg. 645)
26. Corporate Debt Markets (pg. 647)
Contents (pg. 647)
Learning Objectives (pg. 648)
Bank Loans (pg. 649)
Corporate Bonds (pg. 652)
Medium-Term Notes (pg. 666)
Lease Financing (pg. 668)
Insolvency Laws (pg. 669)
Key Points (pg. 673)
Questions (pg. 675)
27. Market for Asset-Backed Securities (pg. 677)
Contents (pg. 677)
Learning Objectives (pg. 677)
Securitization and the Creation of a Securitized Product (pg. 678)
Benefits of Securitization to Financial Markets (pg. 684)
Concerns about Securitization (pg. 686)
Need for the Development of an Accommodating Legal Structure (pg. 687)
Securitization Regulation (pg. 690)
Securitization as a Corporate Risk Management Tool (pg. 691)
Key Points (pg. 693)
Questions (pg. 694)
28. Financing Market for Small, Medium-Sized, and Entrepreneurial Enterprises (pg. 697)
Contents (pg. 697)
Learning Objectives (pg. 698)
Definition of Small and Medium-Sized Enterprises (pg. 699)
Government Programs and Initiatives (pg. 700)
Stages of Development and Financing for a Business Venture (pg. 702)
Sources for Seed Stage Financing (pg. 705)
Expansion Financing (pg. 711)
Equity Dilutive Securities Used for New Ventures (pg. 719)
Key Points (pg. 726)
Questions (pg. 729)
VII. Real Estate Markets (pg. 731)
29. The Residential Mortgage Market (pg. 733)
Contents (pg. 733)
Learning Objectives (pg. 734)
Origination of Residential Mortgage Loans (pg. 735)
Types of Residential Mortgage Loans (pg. 738)
Investment Risks (pg. 747)
Development of the Secondary Mortgage Market (pg. 749)
Key Points (pg. 751)
Questions (pg. 754)
Appendix: Mortgage Mathematics (pg. 756)
30. Residential Mortgage-Backed Securities Market (pg. 761)
Contents (pg. 761)
Learning Objectives (pg. 762)
Agency RMBS Market (pg. 763)
Private-Label RMBSs (pg. 785)
Key Points (pg. 790)
Questions (pg. 791)
31. Commercial Real Estate Markets (pg. 793)
Contents (pg. 793)
Learning Objectives (pg. 794)
Categories of the Commercial Real Estate Market (pg. 794)
Primary Reasons Offered for Investing in Commercial Real Estate (pg. 795)
Private Commercial Real Estate Equity (pg. 798)
Public Commercial Real Estate Equity (pg. 800)
Private Commercial Real Estate Debt (pg. 803)
Public Commercial Real Estate Debt (pg. 805)
Investors in the Commercial Real Estate Market (pg. 808)
Key Points (pg. 811)
Questions (pg. 813)
VIII. Collective Investment Vehicles and Financial Derivatives Markets (pg. 815)
32. Market for Collective Investment Vehicles (pg. 817)
Contents (pg. 817)
Learning Objectives (pg. 818)
Investment Company Shares (pg. 819)
Concerns about Hedge Funds in Financial Markets (pg. 834)
REITs (pg. 835)
Venture Capital Funds (pg. 837)
Key Points (pg. 840)
Questions (pg. 842)
33. Financial Futures Markets (pg. 845)
Contents (pg. 845)
Learning Objectives (pg. 846)
Futures Contracts (pg. 847)
Futures versus Forward Contracts (pg. 853)
Risk-Sharing versus Insurance Arrangements (pg. 853)
Stock-Related Contracts (pg. 855)
Interest Rate Futures Contracts (pg. 858)
Currency Forward and Futures Contracts (pg. 863)
Role of Futures Contracts in Financial Markets (pg. 864)
Key Points (pg. 868)
Questions (pg. 870)
34. Options Markets (pg. 873)
Contents (pg. 873)
Learning Objectives (pg. 874)
Options Contracts (pg. 874)
Differences between Options and Futures Contracts (pg. 876)
Risk and Return Characteristics of Options (pg. 877)
Economic Role of the Options Markets (pg. 886)
U.S. Options Markets (pg. 888)
Futures Options (pg. 893)
Key Points (pg. 896)
Questions (pg. 897)
35. Pricing Futures and Options Contracts (pg. 899)
Contents (pg. 899)
Learning Objectives (pg. 900)
Pricing of Futures Contracts (pg. 900)
Pricing of Options (pg. 910)
Key Points (pg. 924)
Questions (pg. 925)
36. Applications of Futures and Options Contracts (pg. 929)
Contents (pg. 929)
Learning Objectives (pg. 930)
Applications of Futures Contracts (pg. 930)
Applications of Options Contracts (pg. 936)
Key Points (pg. 938)
Questions (pg. 938)
Appendix: General Principles of Hedging with Futures (pg. 941)
Risks Associated with Hedging (pg. 942)
Short Hedge and Long Hedge (pg. 942)
Illustrations of Hedging (pg. 943)
37. Over-the-Counter Interest Rate Derivatives: Forward Rate Agreements, Swaps, Caps, and Floors (pg. 955)
Contents (pg. 955)
Learning Objectives (pg. 956)
Forward Rate Agreements (pg. 956)
Interest Rate Swaps (pg. 959)
Interest Rate Caps and Floors (pg. 980)
Key Points (pg. 983)
Questions (pg. 984)
38. Market for Foreign Exchange Derivatives (pg. 989)
Contents (pg. 989)
Learning Objectives (pg. 989)
FX Forward Contracts (pg. 990)
Pricing FX Forward Contracts (pg. 991)
FX Futures Contracts (pg. 996)
Currency Option Contracts (pg. 997)
FX Swaps and Currency Swaps (pg. 998)
Key Points (pg. 1003)
Questions (pg. 1003)
39. Market for Credit Risk Transfer Vehicles (pg. 1007)
Contents (pg. 1007)
Learning Objectives (pg. 1008)
Credit Derivatives (pg. 1009)
Credit Default Swaps (pg. 1012)
Collateralized Debt Obligations (pg. 1017)
Credit-Linked Notes (pg. 1020)
Concerns about CRT Vehicles (pg. 1021)
Key Points (pg. 1025)
Questions (pg. 1026)
Index (pg. 1029)

Frank J. Fabozzi

Frank J. Fabozzi is Professor of Finance at EDHEC Business School, France. He has held positions at Princeton University, Yale School of Management, and MIT Sloan School of Management. He is the author of Capital Markets (fifth edition, MIT Press), Entrepreneurial Finance and Accounting for High-Tech Companies (MIT Press), and other books.

Frank J. Jones

Frank J. Jones is Professor of Finance and Accounting at San Jose State College of Business. His previous positions in finance include Chairman of the International Securities Exchange and Director of Global Fixed Income Research and Economics at Merrill Lynch.

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