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CHAPTER ONE 

WHY STUDY FINANCIAL MARKETS AND INSTITUTIONS?

 

REQUIREMENTS

Chapter one shows the student that financial markets and institutions is an exciting field because it focuses on phenomena that affect everyday life. The students need to have an overview for the entire book, previewing the topics that will be covered in later chapters.

 

STRUCTURE

Why study Financial Markets?

Debt Market and Interest Rates

The Stock Market

The Foreign Exchange Market

Why study Financial Institutions?

Central Banks and the Conduct of Monetary Policy

Structure of the Financial System

Banks and Other Financial Institutions

Managing Risk in Financial Institutions

How we will study Financial Markets?

 

KEY POINTS:

Financial markets, Foreign exchange market, Financial intermediaries

 

CHAPTER TWO

 

OVERVIEW OF THE FINANCIAL SYSTEM

 

REQUIREMENTS

Chapter 2 is an introductory chapter that contains the background information on the structure and operation of financial markets that is needed in later chapters of the book. The most important point to transmit to the student is that financial markets and financial intermediaries are crucial to a well-functioning economy because they channel funds from those who do not have a productive use for them to those who do.

 

STRUCTURE

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

Internationalization of Financial Markets

International Bond Market, Eurobonds and Eurocurrencies

World Stock Markets

Function of Financial Intermediaries

Transactions Costs

 

Asymmetric Information: Adverse Selection and Moral Hazard

 

Financial Institutions

Depository Institutions

Contractual Savings Institutions

Investment Intermediaries

 

Regulation of the Financial System

Increasing Information Available to Investors

Ensuring the Soundness of Financial Intermediaries

Improving Control of Monetary Policy

Financial Regulation Abroad

 

KEY POINTS:

 

OTC markets, Eurobond, Eurocurrencies, Eurodollars, Transaction costs, asymmetric information, adverse selection, moral hazard

 

CHAPTER THREE


UNDERSTANDING INTEREST RATES

 

REQUIREMENTS

 

The student will understand the interest rate is negatively associated with the price of a bond, that it differs from the return on a bond, and that there is an important distinction between real and nominal interest rates.

 

STRUCTURE

 

Measuring Interest Rates

 

Present Value

 

Yield to Maturity

 

Other Measures of Interest Rates

 

Current Yield

Yield on a Discount Basis

The Distinction Between Real And Nominal Interest rates

The Distinction Between Interest Rates and Returns

Maturity and the Volatility of Bond Returns: Interest-Rate Risk

Reinvestment Risk

 

The Practicing Financial Institution Manager: Calculating Duration to Measure Interest-Rate Risk

 

Calculating Duration

 

Duration and Interest-Rate Risk

 

KEY POINTS:

 

discount bond, present value, yield to maturity, coupon bond, current yield, real interest rate, rate of return, interest rate risk, duration

 

CHAPTER FOUR 


THE BEHAVIOR OF INTEREST RATES

 

REQUIREMENTS

 

The student will develop their intuition through this chapter. The exercise will give them good practice in developing their analytic abilities. The rest of Chapter 4 will lays out two partial equilibrium approaches to the determination of interest rates: the loanable funds framework and the liquidity preference framework.

 

STRUCTURE

 

Determinants of Asset Demand

Wealth

Expected Returns

Risk

Liquidity

Summary

Benefits of Diversification

Loanable Funds Framework: Supply an Demand in the Bond Market

Demand-Curve

Supply-Curve

Market Equilibrium

 

WORKS IN PROGRESS...

 

  Supply and Demand Analysis

 

Changes in Equilibrium Interest Rates

 

  Shifts in the Demand for Bonds

 

  Shifts in the Supply of Bonds

 

    Changes in Expected Inflation: The Fischer Effect

 

    Business Cycle Expansion

 

      Liquidity Preference Framework: Supply and Demand in the Market for Money

 

      Changes in Equilibrium Interest Rates

 

      Changes in Income

 

      Changes in the Price Level

 

      Changes in the Money Supply

 

      Does a Higher Rate of Growth of the Money Supply Lower Interest Rates?

 

      The Practicing Financial Institutions Manager: Profiting from Interest-rate Forecasts?

 

KEY POINTS:

 

expected return, liquidity, demand curve, supply curve, market equilibrium, business cycle, income effect

 

 

 

CHAPTER FIVE 

THE RISK AND TERM STRUCTURE OF INTEREST RATES

 

REQUIREMENTS

 

Chapter 5 applies the tools the student learned in Chapter 4 to understanding why and how various interest rates differ. In courses that emphasize financial markets, this chapter is important because students are curious about the risk and term structure of interest rates. A particularly attractive feature of this chapter is that it gives students a feel for the interaction of data and theory.

 

STRUCTURE

 

Risk Structure of Interest Rates

 

    Default Risk

 

  Liquidity

 

   Income Tax Considerations

 

Term Structure of Interest Rates

 

  Pure Expectations Theory

 

  Market Segmentation Theory

 

    Liquidity Premium Theory

 

    Evidence on the Term Structure

 

KEY POINTS:

 

default risk, liquidity, yield curve, term structure of interest rates

 

CHAPTER SIX 

THE THEORY OF EFFICIENT CAPITAL MARKETS

 

REQUIREMENTS

 

The students will understand the important development in finance theory that has far-reaching implications is the theory of rational expectations, which is called the theory of efficient capital markets when it is applied to financial markets. When provided with a graphic example like that used in the text, students have no trouble understanding the theory of rational expectations, which is really just good common sense.

 

STRUCTURE

 

Theory of Rational Expectations

 

    Formal Statement of the Theory

 

    Rational Behind the Theory

 

    Implications of the Theory

 

Efficient Markets Theory: Rational Expectations in Financial Markets

 

    Rationale Behind the Theory

 

    Stronger VERSION of Efficient Markets Theory

 

Evidence on Efficient Markets Theory

 

    Evidence in Favor of Market Efficiency

 

    Evidence Against Market Efficiency

 

    Overview of the Evidence on Efficient Markets Theory

 

The Practicing Financial Institution Manager: Practical Guide to Investing in the Stock Market

 

    How Valuable are Published Reports by Investment Advisors?

 

Should You Be Skeptical of Hot Tips?

 

  Do Stock Prices Always Rise When There is Good News?

 

    Efficient Markets Prescription for the Investor

 

KEY POINTS:

 

adaptive expectations, market fundamentals, rational expectations, mean reversion, unexploited profit opportunity, efficient markets theory, random walk

 

 

 

CHAPTER SEVEN   

 

THE STRUCTURE OF CENTRAL BANKS AND THE FEDERAL RESERVE SYSTEM

 

    REQUIREMENTS

 

In this chapter we look at the institutional structure of major central banks and particularly focus on the United States. The students need to understand the structure of the Fed and how the Fed operates. With this information, the students will be more able to comprehend the actual conduct of monetary policy described in the following chapters.

 

STRUCTURE

 

Origin of the Federal Reserve System

 

Formal Structure of the Federal Reserve System

 

    Federal Reserve Banks

 

    Member Banks

 

    Board of Governors of the Federal Reserve System

 

    Federal Open Market Committee (FOMC)

 

    The FOMC Meeting

 

Informal Structure of the Federal Reserve System

 

How Independent is the Fed?

 

Structure and Independence of Foreign Central Banks

 

    Bank of Canada

 

    Bank of England

 

    Bank of Japan

 

    European Central Bank

 

    The Trend Toward Greater Independence

 

    Explaining the Central Bank Behavior

 

Should the Fed be Independence?

 

    The Case for Independence

 

    The Case Against Independence

 

Central Bank Independence and Macroeconomic Performance in Seventeen    Countries

 

KEY POINTS

 

Board of Governors of the Federal Reserve System, Federal Open Market Committee (FOMC), Federal Reserve banks, open market operations,    political business cycle

 

 

 

CHAPTER 8

 

CONDUCT OF MONETARY POLICY:TOOLS,GOALS,AND TARGETS

 

REQUIREMENTS

 

The students should know the Federal Reserve’s balance sheet, the tools, goals of monetary policy, and can analyze the market for reserves, how monetary policy affects the federal funds rate. Then the students should make it clear that how the fed uses its tools in theory and in practice and understand two basic strategies for monetary policy: monetary targeting and inflation targeting.

 

STRUCTURE

 

The Federal Reserve’s Balance Sheet

 

        Liabilities

 

        Assets

 

        Open Market Operations

 

        Discount Lending

 

    The Market for Reserves and the Federal Funds Rate

 

        Supply and Demand in the Market for Reserves

 

        How Changes in the Tools of Monetary Policy Affect the Federal Funds Rate

 

    Tools of Monetary Policy

 

        Open Market Operations

 

        A Day at the Trading Desk

 

        Discount Policy

 

        Operations of the Discount Window

 

        Lender of Last Resort

 

        Announcement Effect

 

        Reserve Requirements

 

        Advantages of Open market Operations over the Other Tools

 

    Goals of Monetary Policy

 

        High Employment

 

        Economic Growth

 

        Price Stability

 

        Interest-Rate Stability

 

        Stability in Financial Markers

 

        Conflict Among Goals

 

    Central Bank Strategy : Use of Targets

 

    Choosing the Targets

 

        Criteria for Choosing Intermediate Targets

 

        Criteria for Choosing Operating Targets

 

    Fed Policy Procedures : Historical Perspective

 

        The Early Years: Discount Policy as the Primary Tool

 

        Discovery of Open Market Operations

 

        The Great Depression

 

      War Finance and the Pegging of Interest Rates: 1942-1951

 

      Targeting Money Market Conditions: The 1950s and 1960s

 

      Targeting Monetary Aggregates: The 1970s

 

      New Fed Operating Procedures: October 1979-October 1982

 

      Deemphasis of Monetary Aggregates: October 1982-Early 1990s

 

      Federal Funds Targeting Again: Early 1990s and Beyond

 

    International Considerations

 

    Monetary Targeting in Other Countries

 

    The New International Trend in Monetary Policy Strategy: Inflation Targeting

 

The Practicing Financial Institution Manager : Using a Fed Watcher

 

KEY POINTS:

 

    open market operations, discount rate, discount window, federal funds rate, reserve requirements, intermediate target, operating target, international policy coordination

 

 

 

CHAPTER 9

 

THE MONEY MARKETS

 

REQUIREMENTS:

 

This chapter explores the institutional feature of the money markets. The students should know why money markets are needed and the purpose of them to the government, firms, financial institutions, and individuals. Then the students need to understand the money market instruments: treasury bills, federal funds, CDs, commercial paper, Eurodollars, and the characteristics of the instruments: interest rates, maturity, liquidity.

 

STRUCTURE:

 

    The Money Markets Defined

 

        Why Do We Need Money Markets?

 

        Cost Advantages

 

    The Purpose of the Money Markets

 

    Who Participates in the Money Markets?

 

    U.S. Treasury Department

 

    Federal Reserve System

 

    Commercial Banks

 

    Businesses

 

    Investment and Securities Firms

 

    Individuals

 

Money Market Instruments

 

    Treasury Bills

 

    Federal Funds

 

    Repurchase Agreements

 

    Negotiable Certificates of Deposit

 

    Commercial Paper

 

    Banker’s Acceptances

 

    Eurodollars

 

    Comparing Money Market Securities

 

    Interest Rates

 

    Liquidity

 

    Money Market Mutual Funds

 

    History of Money Market Mutual Funds

 

    Description of Money Market Mutual Funds

 

    MMMF Risk

 

    Current Trends in MMMFs

 

    KEY POINTS:

 

    bearer instrument, money market , money market instrument, LIBOR, LIBID, treasury bill , repurchase agreements , negotiable certificates of deposit , commercial paper , banker’s acceptance , money market mutual funds

 

 

 

CHAPTER 10

 

THE CAPITAL MARKETS

 

    REQUIREMENTS:

 

At first the students will know the purpose of and the participants in the capital market. Then the students will get a better understanding of two categories of capital markets: bonds and stocks and the different types of Treasury securities, the difference between stocks which represent ownership and bonds which represent no ownership to the company.

 

STRUCTURE:

 

    Purpose of the Capital Market

 

    Capital Market Participants

 

    Capital Market Trading

 

    Organized Securities Exchanges

 

    Over-the-Counter Markets

 

    Capital Market Securities: Bonds

 

    Treasury Bonds

 

        Application: Interest-Rate Risk in Bond Investment

 

    Treasury Bond Interest Rates

 

    Treasury Strips

 

    Agency Bonds

 

    Municipal Bonds

 

    Risk in the Municipal Bond Market

 

    Corporate Bonds

 

    Characteristics of Corporate Bonds

 

    Types of Corporate Bonds

 

    Financial Guarantees for Bonds

 

    Trends in the Bond Market

 

    Capital Market Securities: Stock

 

Common Stock Versus Preferred Stock

 

    Application: The Valuation of Common Stock

 

    Stock Market Indexes

 

    Buying Foreign Stock

 

    Public Issues of Stocks and Bonds

 

    Using Investment Bankers

 

Private Placement

 

KEY POINTS:

 

    capital market , capital market participants , capital market trading , capital market securities , initial public offering(IPO), STRIPS, financial guarantee, American depository receipts(ADRs), syndicate , underwriting

 

 

 

CHAPTER 11

 

THE MORTGAGE MARKETS

 

REQUIREMENTS:

 

The students should understand the definition of the mortgage markets and mortgage loans. Then the students will get a full understanding of the interest rates on mortgages and how they are determined for different types of rates, terms, and discount points. The mortgage-backed security is an important concept, so the students should hold the types and characteristics of them.

 

STRUCTURE:

 

    What are Mortgage?

 

    Characteristics of the Residential Mortgage

 

    Mortgage Interest Rates

 

    Loan Terms

 

    Mortgage Loan Amortization

 

    Types of Mortgage Loans

 

    Insured and Conventional Mortgages

 

    Fixed-and adjustable-rate Mortgages

 

    Other Types of Mortgages

 

    Mortgage-lending Institutions

 

    Loan Servicing

 

    Secondary Mortgage Market

 

    Mortgage Backed Securities

 

    What is a Mortgage-Backed Security?

 

    Types of Pass-through Securities

 

    Mortgage-Backed Security Clearing Corporation

 

The Impact of Securitized Mortgages in the Mortgage Market

 

KEY POINTS:

 

mortgage, amortized, insured mortgage, private mortgage insurance, discount points, down payment, conventional mortgage, collateralized mortgage obligation, mortgage-backed security, securitized mortgage, mortgage pass-through

 

 

 

CHAPTER 12

 

THE FOREIGN EXCHAGE MARKETS

 

REQUIREMENTS:

 

The students should understand the behavior in the foreign exchange market by using a modern asset-market approach to exchange rate determination. To help students achieve an intuitive grasp of how the expected return on domestic and foreign deposits schedules shift, tell them to put themselves in the shoes of an investor who is thinking about putting his money into foreign or domestic deposits.

 

STRUCTURE:

 

    Foreign Exchange Market

 

    What are Foreign Exchange Rates?

 

    Why are Exchange Rates Important?

 

    How is Foreign Exchange Traded?

 

    Exchange Rates in the Long Run

 

    Law of One Price

 

    Theory of Purchasing Power Parity: Why the Theory of Purchasing Power Parity 

 

    Cannot Fully Explain Exchange Rates?

 

    Factors That Affect Exchange Rates in the Long Run

 

    Exchange Rates in the Short Run

 

    Comparing Expected Returns on Domestic and Foreign Deposits

 

    Interest Parity condition

 

    Equilibrium in the Foreign Exchange Market

 

    Explaining changes in Exchange Rates

 

    Shift in the Expected-Return Schedule for Foreign Deposits

 

    Shift in the Expected-Return Schedule for Domestic Deposits

 

    Changes in Domestic Interest Rates

 

    Changes in the Money Supply

 

    Exchange Rate Overshooting

 

KEY POINTS:

 

foreign exchange market, appreciation, depreciation, effective exchange rate index, theory of purchasing power parity, interest parity condition, law of one price, exchange rate overshooting

 

 

 

CHAPTER 13

 

THE INTERNATIONAL FINANCIAL SYSTEM AND MONETARY POLICY

 

REQUIREMENTS:

 

The students should make it clear why international financial transactions have important implication for financial institutions and the conduct of monetary policy. Then the students should know how foreign exchange market intervention affects the exchange rate, a country’s international reserves and the money supply, and how monetary policy can be affected by international financial transactions.

 

STRUCTURE:

 

    Intervention in the Foreign Exchange Market

 

    Foreign Exchange Intervention and the Money Supply

 

    Unsterilized Intervention

 

    Sterilized Intervention

 

    Balance of Payments

 

    Current Account

 

    Capital Account

 

    Official Reserve Transactions Balance

 

        Methods of Financing the Balance of Payments

 

    Evolution of the International Financial System

 

    Gold Standard

 

    Bretton Woods System and the IMF

 

    Managed Float

 

    European Monetary System

 

    The Practicing Financial Institution Manager: Profiting from a Foreign Exchange Crisis

 

    International Considerations and Monetary Policy

 

    Direct Effects of the Foreign Exchange Market of the Money Supply

 

    Balance-of-Payments Considerations

 

    Exchange Rate Considerations

 

KEY POINTS:

 

    balance of payments, gold standard, special drawing rights, unsterilized intervention, sterilized intervention, foreign exchange intervention, Bretton woods System, managed float regime, fixed exchange rate regime, reserve currency, international reserves

 

 




 

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