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Unformatted text preview: Financial Markets and Institutions Ninth Edition A01_MISH9265_09_SE_FM.indd 1 11/23/16 3:33 PM The Pearson Series in Finance Berk/DeMarzo Gitman/Zutter Corporate Finance* Corporate Finance: The Core* Berk/DeMarzo/Harford Fundamentals of Corporate Finance* Financial Management: Core Concepts* Copeland/Weston/Shastri Financial Theory and Corporate Policy Dorfman/Cather Introduction to Risk Management and Insurance Eakins/McNally Corporate Finance Online* Eiteman/Stonehill/Moffett Multinational Business Finance Holden Excel Modeling in Corporate Finance Excel Modeling in Investments Hughes/MacDonald International Banking: Text and Cases Hull Fundamentals of Futures and Options Markets Options, Futures, and Other Derivatives Keown Fabozzi Bond Markets: Analysis and Strategies Personal Finance: Turning Money into Wealth* Keown/Martin/Petty Foerster Financial Management: Concepts and Applications* Personal Finance Haugen The Inefficient Stock Market: What Pays Off and Why The New Finance: Overreaction, Complexity, and Uniqueness Brooks Frasca Principles of Managerial Finance* Principles of Managerial Finance––Brief Edition* Foundations of Finance: The Logic and Practice of Financial Management* Madura Personal Finance* McDonald Derivatives Markets Fundamentals of Derivatives Markets Mishkin/Eakins Financial Markets and Institutions Moffett/Stonehill/Eiteman Fundamentals of Multinational Finance Pennacchi Theory of Asset Pricing Rejda/McNamara Principles of Risk Management and Insurance Smart/Gitman/Joehnk Fundamentals of Investing* Solnik/McLeavey Global Investments Titman/Keown/Martin Financial Management: Principles and Applications* Titman/Martin Valuation: The Art and Science of Corporate Investment Decisions Weston/Mitchel/Mulherin Takeovers, Restructuring, and Corporate Governance *denotes MyFinanceLab titles     Log onto to learn more. A01_MISH9265_09_SE_FM.indd 2 11/23/16 3:33 PM Financial Markets and Institutions Ninth Edition Frederic S. Mishkin Graduate School of Business, Columbia University Stanley G. Eakins East Carolina University New York, NY A01_MISH9265_09_SE_FM.indd 3 11/23/16 3:35 PM Vice President, Business Publishing: Donna Battista Director of Portfolio Management: Adrienne D’Ambrosio Senior Portfolio Manager: Christina Masturzo Vice President, Product Marketing: Roxanne McCarley Director of Strategic Marketing: Brad Parkins Strategic Marketing Manager: Deborah Strickland Product Marketer: Tricia Murphy Field Marketing Manager: Ramona Elmer Field Marketing Assistant: Kristen Compton Product Marketing Assistant: Jessica Quazza Vice President, Production and Digital Studio, Arts and Business: Etain O’Dea Director of Production, Business: Jeff Holcomb Managing Producer, Business: Alison Kalil Content Producer: Kathryn Brightney Operations Specialist: Carol Melville Creative Director: Blair Brown Manager, Learning Tools: Brian Surette Content Developer, Learning Tools: Lindsey Sloan Managing Producer, Digital Studio, Arts and Business: Diane Lombardo Digital Studio Producer: Melissa Honig Digital Studio Producer: Alana Coles Digital Content Team Lead: Noel Lotz Full-Service Project Management and Composition: Cenveo® Publisher Services Interior Design: Cenveo® Publisher Services Cover Design: Cenveo® Publisher Services Cover Art: Top left: Piboolchai / Shutterstock; top right: TravnikovStudio / Shutterstock; bottom left: Bummi100 / Fotalia; bottom right: Alterov / Shutterstock Printer/Binder: R R Donnelley, Willard Cover Printer: Phoenix Color 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. All such documents and related graphics are provided “as is” without warranty of any kind. Microsoft and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all warranties and conditions of merchantability, whether express, implied or statutory, fitness for a particular purpose, title and non-infringement. In no event shall Microsoft and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from the services. The documents and related graphics contained herein could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Microsoft and/or its respective suppliers may make improvements and/ or changes in the product(s) and/or the program(s) described herein at any time. Partial screen shots may be viewed in full within the software version specified. Microsoft® and Windows® are registered trademarks of the Microsoft Corporation in the U.S.A. and other countries. This book is not sponsored or endorsed by or affiliated with the Microsoft Corporation. Copyright © 2018, 2015, 2012 by Frederic S. Mishkin. All Rights Reserved. Manufactured in the United States of America. This publication is protected by copyright, and permission should be obtained from the publisher prior to any prohibited reproduction, storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise. For information regarding permissions, request forms, and the appropriate contacts within the Pearson Education Global Rights and Permissions department, please visit . Acknowledgments of third-party content appear on the appropriate page within the text. PEARSON AND ALWAYS LEARNING are exclusive trademarks owned by Pearson Education, Inc. or its affiliates in the U.S. and/or other countries. Unless otherwise indicated herein, any third-party trademarks, logos, or icons that may appear in this work are the property of their respective owners, and any references to third-party trademarks, logos, icons, or other trade dress are for demonstrative or descriptive purposes only. Such references are not intended to imply any sponsorship, endorsement, authorization, or promotion of Pearson’s products by the owners of such marks, or any relationship between the owner and Pearson Education, Inc., or its affiliates, authors, licensees, or distributors. Cataloging-in-Publication Data is on file at the Library of Congress 1 16 ISBN 10: 0-13-451926-4 ISBN 13: 978-0-13-451926-5 A01_MISH9265_09_SE_FM.indd 4 11/23/16 3:35 PM To My Dad —F. S. M. To My Wife, Laurie —S. G. E. A01_MISH9265_09_SE_FM.indd 5 11/23/16 3:35 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 Contents on the Web Preface About the Authors Part One Introduction 1 Why Study Financial Markets and Institutions? 2 Overview of the Financial System Part Two Fundamentals of Financial Markets 3 What Do Interest Rates Mean and What Is Their Role in Valuation? 4 Why Do Interest Rates Change? 5 How Do Risk and Term Structure Affect Interest Rates? 6 Are Financial Markets Efficient? Part Three Fundamentals of Financial Institutions 7 Why Do Financial Institutions Exist? 8 Why Do Financial Crises Occur and Why Are They So Damaging to the Economy? Part Four Central Banking and the Conduct of Monetary Policy 9 Central Banks and the Federal Reserve System 10 Conduct of Monetary Policy Part Five Financial Markets ix xxvii xxxi xxxix 1 1 15 37 37 66 89 117 135 135 166 185 185 208 249 11 The Money Markets 12 The Bond Market 13 The Stock Market 14 The Mortgage Markets 15 The Foreign Exchange Market 16 The International Financial System 249 272 297 318 339 367 Part Six The Financial Institutions Industry 389 17 Banking and the Management of Financial Institutions 18 Financial Regulation 19 Banking Industry: Structure and Competition 20 The Mutual Fund Industry 389 415 443 479 vii A01_MISH9265_09_SE_FM.indd 7 11/23/16 3:35 PM viii Contents in Brief 21 Insurance Companies and Pension Funds 22 Investment Banks, Security Brokers and Dealers, and Venture Capital Firms 504 558 Part Seven The Management of Financial Institutions 23 Risk Management in Financial Institutions 24 Hedging with Financial Derivatives Glossary Index 534 558 579 G-1 I-1 Chapters on the Web 25 Financial Crises in Emerging Market Economies 26 Savings Associations and Credit Unions 27 Finance Companies A01_MISH9265_09_SE_FM.indd 8 W-1 W-22 W-49 11/23/16 3:35 PM Contents in Detail Contents on the Web Preface About the Authors Part One Introduction Chapter 1 Why Study Financial Markets and Institutions? Preview Why Study Financial Markets? Debt Markets and Interest Rates The Stock Market The Foreign Exchange Market Why Study Financial Institutions? Structure of the Financial System Financial Crises Central Banks and the Conduct of Monetary Policy The International Financial System Banks and Other Financial Institutions Financial Innovation Managing Risk in Financial Institutions Applied Managerial Perspective How We Will Study Financial Markets and Institutions Exploring the Web Collecting and Graphing Data Web Exercise Concluding Remarks Summary Key Terms Questions Quantitative Problems Web Exercises xxvii xxxi xxxix Chapter 2 Overview of the Financial System Preview Function of Financial Markets Structure of Financial Markets Debt and Equity Markets Primary and Secondary Markets Exchanges and Over-the-Counter Markets Money and Capital Markets 1 1 2 2 3 4 6 6 6 7 7 7 7 8 8 9 9 10 10 12 12 13 13 14 14 15 15 16 18 18 18 19 20 ix A01_MISH9265_09_SE_FM.indd 9 11/23/16 3:35 PM x Contents in Detail Internationalization of Financial Markets International Bond Market, Eurobonds, and Eurocurrencies GLOBAL  Are U.S. Capital Markets Losing Their Edge? World Stock Markets Function of Financial Intermediaries: Indirect Finance FOLLOWING THE FINANCIAL NEWS  Foreign Stock Market Indexes GLOBAL  The Importance of Financial Intermediaries Relative to Securities Markets: An International Comparison Transaction Costs Risk Sharing Asymmetric Information: Adverse Selection and Moral Hazard Economies of Scope and Conflicts of Interest Types of Financial Intermediaries Depository Institutions Contractual Savings Institutions Investment Intermediaries Regulation of the Financial System Increasing Information Available to Investors Ensuring the Soundness of Financial Intermediaries Financial Regulation Abroad Summary Key Terms Questions Web Exercises 20 20 21 22 22 23 23 23 24 25 26 27 27 28 30 31 32 32 33 34 35 35 36 Part Two Fundamentals of Financial Markets Chapter 3 What Do Interest Rates Mean and What Is Their Role in Valuation? Preview Measuring Interest Rates Present Value Four Types of Credit Market Instruments Yield to Maturity GLOBAL  Negative Interest Rates? Japan First, Then the United States, Then Europe The Distinction Between Real and Nominal Interest Rates MINI-CASE  With TIPS, Real Interest Rates Have Become Observable in the United States The Distinction Between Interest Rates and Returns Maturity and the Volatility of Bond Returns: Interest-Rate Risk MINI-CASE  Helping Investors Select Desired Interest-Rate Risk Reinvestment Risk Summary THE PRACTICING MANAGER  Calculating Duration to Measure Interest-Rate Risk Calculating Duration Duration and Interest-Rate Risk A01_MISH9265_09_SE_FM.indd 10 37 37 38 38 40 41 47 48 51 51 54 55 55 56 56 57 61 11/23/16 3:35 PM Contents in Detail Summary Key Terms Questions Quantitative Problems Web Exercises Chapter 4 Why Do Interest Rates Change? xi 62 63 63 63 65 66 Preview Determinants of Asset Demand Wealth Expected Returns Risk Liquidity Theory of Portfolio Choice Supply and Demand in the Bond Market Demand Curve Supply Curve Market Equilibrium Supply-and-Demand Analysis Changes in Equilibrium Interest Rates Shifts in the Demand for Bonds Shifts in the Supply of Bonds CASE  Changes in the Interest Rate Due to Expected Inflation: The Fisher Effect CASE  Changes in the Interest Rate Due to a Business Cycle Expansion CASE  Explaining the Current Low Interest Rates in Europe, Japan, and the United States THE PRACTICING MANAGER  Profiting from Interest-Rate Forecasts FOLLOWING THE FINANCIAL NEWS  Forecasting Interest Rates Summary Key Terms Questions Quantitative Problems Web Exercises Web Appendices 83 84 86 86 86 86 87 88 88 Chapter 5 How Do Risk and Term Structure Affect Interest Rates? 89 Preview Risk Structure of Interest Rates Default Risk Liquidity CASE  The Global Financial Crisis and the Baa-Treasury Spread Income Tax Considerations Summary CASE  Effects of the Bush Tax Cut and the Obama Tax Increase on Bond Interest Rates Term Structure of Interest Rates A01_MISH9265_09_SE_FM.indd 11 66 67 67 67 68 70 70 70 71 72 73 74 74 75 78 80 82 89 90 90 93 93 94 95 96 97 11/23/16 3:35 PM xii Contents in Detail FOLLOWING THE FINANCIAL NEWS  Yield Curves Expectations Theory Market Segmentation Theory Liquidity Premium Theory Evidence on the Term Structure Summary MINI-CASE  The Yield Curve as a Forecasting Tool for Inflation and the Business Cycle CASE  Interpreting Yield Curves, 1980–2016 THE PRACTICING MANAGER  Using the Term Structure to Forecast Interest Rates Summary Key Terms Questions Quantitative Problems Web Exercises Chapter 6 Are Financial Markets Efficient? Preview The Efficient Market Hypothesis Rationale Behind the Hypothesis Evidence on the Efficient Market Hypothesis Evidence in Favor of Market Efficiency MINI-CASE  An Exception That Proves the Rule: Raj Rajaratnam and Galleon CASE  Should Foreign Exchange Rates Follow a Random Walk? Evidence Against Market Efficiency Overview of the Evidence on the Efficient Market Hypothesis THE PRACTICING MANAGER  Practical Guide to Investing in the Stock Market How Valuable Are Published Reports by Investment Advisers? MINI-CASE  Should You Hire an Ape as Your Investment Adviser? Should You Be Skeptical of Hot Tips? Do Stock Prices Always Rise When There Is Good News? Efficient Markets Prescription for the Investor Why the Efficient Market Hypothesis Does Not Imply That Financial Markets Are Efficient CASE  What Do Stock Market Crashes Tell Us About the Efficient Market Hypothesis? Behavioral Finance Summary Key Terms Questions Quantitative Problems Web Exercises 98 99 103 104 107 108 109 109 110 113 114 114 115 116 117 117 118 120 121 121 122 124 125 127 127 127 128 128 129 129 130 131 131 132 133 133 134 134 Part Three Fundamentals of Financial Institutions Chapter 7 Why Do Financial Institutions Exist? Preview Basic Facts About Financial Structure Throughout The World A01_MISH9265_09_SE_FM.indd 12 135 135 136 11/23/16 3:35 PM Contents in Detail Transaction Costs How Transaction Costs Influence Financial Structure How Financial Intermediaries Reduce Transaction Costs Asymmetric Information: Adverse Selection and Moral Hazard The Lemons Problem: How Adverse Selection Influences Financial Structure Lemons in the Stock and Bond Markets Tools to Help Solve Adverse Selection Problems MINI-CASE  The Enron Implosion How Moral Hazard Affects the Choice Between Debt and Equity Contracts Moral Hazard in Equity Contracts: The Principal–Agent Problem Tools to Help Solve the Principal–Agent Problem How Moral Hazard Influences Financial Structure in Debt Markets Tools to Help Solve Moral Hazard in Debt Contracts Summary CASE  Financial Development and Economic Growth MINI-CASE  The Tyranny of Collateral CASE  Is China a Counter-Example to the Importance of Financial Development? Conflicts of Interest What Are Conflicts of Interest and Why Do We Care? Why Do Conflicts of Interest Arise? MINI-CASE  The Demise of Arthur Andersen MINI-CASE Credit-Rating Agencies and the 2007–2009 Financial Crisis What Has Been Done to Remedy Conflicts of Interest? MINI-CASE  Has Sarbanes-Oxley Led to a Decline in U.S. Capital Markets? Summary Key Terms Questions Quantitative Problems Web Exercises xiii 139 139 139 140 141 142 142 144 147 147 148 150 150 152 154 155 156 157 157 157 159 160 160 162 162 163 163 164 165 Chapter 8 Why Do Financial Crises Occur and Why Are They So Damaging to the Economy? 166 Preview What Is a Financial Crisis? Agency Theory and the Definition of a Financial Crisis Dynamics of Financial Crises Stage One: Initial Phase Stage Two: Banking Crisis Stage Three: Debt Deflation CASE  The Mother of All Financial Crises: The Great Depression Stock Market Crash Bank Panics Continuing Decline in Stock Prices 166 167 167 167 167 170 171 171 171 171 172 A01_MISH9265_09_SE_FM.indd 13 11/23/16 3:35 PM xiv Contents in Detail Debt Deflation International Dimensions CASE  The Global Financial Crisis of 2007–2009 Causes of the 2007–2009 Financial Crisis MINI-CASE  Collateralized Debt Obligations (CDOs) Effects of the 2007–2009 Financial Crisis INSIDE THE FED  Was the Fed to Blame for the Housing Price Bubble? GLOBAL  The European Sovereign Debt Crisis Height of the 2007–2009 Financial Crisis Summary Key Terms Questions Web Exercises Web References Part Four Central Banking and the Conduct of Monetary Policy Chapter 9 Central Banks and the Federal Reserve System Preview Origins of the Federal Reserve System INSIDE THE FED  The Political Genius of the Founders of the Federal Reserve System Structure of the Federal Reserve System Federal Reserve Banks INSIDE THE FED  The Special Role of the Federal Reserve Bank of New York Member Banks Board of Governors of the Federal Reserve System Federal Open Market Committee (FOMC) INSIDE THE FED  The Role of the Research Staff Why the Chair of the Board of Governors Really Runs the Show INSIDE THE FED  The FOMC Meeting INSIDE THE FED  Green, Blue, Teal, and Beige: What Do These Colors Mean at the Fed? INSIDE THE FED  Styles of Federal Reserve Chairs: Bernanke and Yellen Versus Greenspan How Independent Is the Fed? Should the Fed Be Independent? The Case for Independence The Case Against Independence Central Bank Independence and Macroeconomic Performance Throughout the World Explaining Central Bank Behavior INSIDE THE FED  The Evolution of the Fed’s Communication Strategy Structure and Independence of the European Central Bank Differences Between the European System of Central Banks and the Federal Reserve System Governing Council How Independent Is the ECB? A01_MISH9265_09_SE_FM.indd 14 173 173 174 174 175 176 177 180 181 182 183 183 183 184 185 185 186 186 187 188 189 190 191 192 193 193 194 195 195 196 198 198 199 200 200 201 202 202 203 204 11/23/16 3:35 PM Contents in Detail Structure and Independence of Other Foreign Central Banks Bank of Canada Bank of England Bank of Japan The Trend Toward Greater Independence Summary Key Terms Questions and Problems Web Exercises Chapter 10 Conduct of Monetary Policy Preview How Fed Actions Affect Reserves in the Banking System Open Market Operations Discount Lending The Market for Reserves and the Federal Funds Rate Demand and Supply in the Market for Reserves How Changes in the Tools of Monetary Policy Affect the Federal Funds Rate CASE  How the Federal Reserve’s Operating Procedures Limit Fluctuations in the Federal Funds Rate Conventional Monetary Policy Tools Open Market Operations INSIDE THE FED  A Day at the Trading Desk Discount Policy and the Lender of Last Resort Reserve Requirements Interest on Reserves Nonconventional Monetary Policy Tools and Quantitative Easing Liquidity Provision INSIDE THE FED  Fed Lending Facilities During the Global Financial Crisis Large-Scale Asset Purchases Quantitative Easing Versus Credit Easing Forward Guidance Negative Interest Rates on Banks’ Deposits Monetary Policy Tools of the European Central Bank Open Market Operations Lending to Banks Interest on Reserves Reserve Requirements The Price Stability Goal and the Nominal Anchor The Role of a Nominal Anchor The Time-Inconsistency Problem Other Goals of Monetary Policy High Employment and Output Stability Economic Growth Stability of Financial Markets Intere...
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