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Contents PART ONE INTRODUCTION Chapter One Why Are Financial Intermediaries Special? Introduction Financial Intermediaries? Specialness FIs Function as Brokers FIs Function as Asset Transformers Information Costs Liquidity and Price Risk Other Special Services Other Aspects of Specialness The Transmission of Monetary Policy Credit Allocation Intergenerational Wealth Transfers or Time Intermediation Payment Services Denomination Intermediation Specialness and Regulation Safety and Soundness Regulation Monetary Policy Regulation Credit Allocation Regulation Consumer Protection Regulation Investor Protection Regulation Entry Regulation The Changing Dynamics of Specialness Trends in the United States Future Trends Global Issues Summary Appendix 1A Monetary Policy Tools (www.mhhe.com/saunders6e) Chapter Two The Financial Services Industry: Depository Institutions Introduction Commercial Banks Size, Structure, and Composition of the Industry Balance Sheet and Recent Trends Other Fee-Generating Activities Regulation Industry Performance Savings Institutions Size, Structure, and Composition of the Industry Balance Sheet and Recent Trends Regulation Industry Performance Credit Unions Size, Structure, and Composition of the Industry Balance Sheet and Recent Trends Regulation Industry Performance Global Issues: Europe, Japan, and China Summary Appendix 2A Financial Statement Analysis Using a Return on Equity (ROE) Framework (www.mhhe.com/saunders6e) Appendix 2B Depository Institutions and Their Regulators (www.mhhe.com/saunders6e) Appendix 2C Technology in Commercial Banking (www.mhhe.com/saunders6e) Chapter Three The Financial Services Industry: Insurance Companies Introduction Life Insurance Companies Size, Structure, and Composition of the Industry Balance Sheet and Recent Trends Regulation Property?Casualty Insurance Size, Structure, and Composition of the Industry Balance Sheet and Recent Trends Regulation Global Issues Summary Chapter Four The Financial Services Industry: Securities Firms and Investment Banks Introduction Size, Structure, and Composition of the Industry Balance Sheet and Recent Trends Recent Trends Balance Sheet Regulation Global Issues Summary Chapter Five The Financial Services Industry: Mutual Funds and Hedge Funds Introduction Size, Structure, and Composition of the Industry Historical Trends Different Types of Mutual Funds Mutual Fund Objectives Investor Returns from Mutual Fund Ownership Mutual Fund Costs Balance Sheet and Recent Trends for the Mutual Fund Industry Money Market Funds Long-Term Funds Regulation of Mutual Funds Global Issues in the Mutual Fund Industry Hedge Funds Types of Hedge Funds Fees on Hedge Funds Offshore Hedge Funds Regulation of Hedge Funds Summary Chapter Six The Financial Services Industry: Finance Companies Introduction Size, Structure, and Composition of the Industry Balance Sheet and Recent Trends Assets Liabilities and Equity Industry Performance Regulation Global Issues Summary Chapter Seven Risks of Financial Intermediation Introduction Interest Rate Risk Market Risk Credit Risk Off-Balance-Sheet Risk Foreign Exchange Risk Country or Sovereign Risk Technology and Operational Risks Liquidity Risk Insolvency Risk Other Risks and the Interaction of Risks Summary Appendix 7A Commercial Banks? Financial Statements and Analysis (www.mhhe.com/saunders6e) PART TWO MEASURING RISK Chapter Eight Interest Rate Risk I Introduction The Level and Movement of Interest Rates The Repricing Model Rate-Sensitive Assets Rate-Sensitive Liabilities Equal Changes in Rates on RSAs and RSLs Unequal Changes in Rates on RSAs and RSLs Weaknesses of the Repricing Model Market Value Effects Overaggregation The Problem of Runoffs Cash Flows from Off-Balance-Sheet Activities Summary Appendix 8A The Maturity Model (www.mhhe.com/saunders6e) Appendix 8B Term Structure of Interest Rates Chapter Nine Interest Rate Risk II Introduction Duration: A Simple Introduction A General Formula for Duration The Duration of Interest-Bearing Bonds The Duration of a Zero-Coupon Bond The Duration of a Consol Bond (Perpetuities) Features of Duration Duration and Yield Duration and Coupon Interest The Economic Meaning of Duration Semiannual Coupon Bonds Duration and Interest Rate Risk Duration and Interest Rate Risk Management on a Single Security Duration and Interest Rate Risk Management on the Whole Balance Sheet of an FI Immunization and Regulatory Concerns Difficulties in Applying the Duration Model Duration Matching Can Be Costly Immunization Is a Dynamic Problem Large Interest Rate Changes and Convexity Summary Appendix 9A The Basics of Bond Valuation (www.mhhe.com/saunders6e) Appendix 9B Incorporating Convexity into the Duration Model Chapter Ten Market Risk Introduction Calculating Market Risk Exposure The RiskMetrics Model The Market Risk of Fixed-Income Securities Foreign Exchange Equities Portfolio Aggregation Historic (Back Simulation) Approach The Historic (Back Simulation) Model versus RiskMetrics The Monte Carlo Simulation Approach Regulatory Models: The BIS Standardized Framework Fixed Income Foreign Exchange Equities The BIS Regulations and Large-Bank Internal Models Summary Chapter Eleven Credit Risk: Individual Loan Risk Introduction Credit Quality Problems Types of Loans Commercial and Industrial Loans Real Estate Loans Individual (Consumer) Loans Other Loans Calculating the Return on a Loan The Contractually Promised Return on a Loan The Expected Return on a Loan Retail versus Wholesale Credit Decisions Retail Wholesale Measurement of Credit Risk Default Risk Models Qualitative Models Credit Scoring Models Newer Models of Credit Risk Measurement and Pricing Term Structure Derivation of Credit Risk Mortality Rate Derivation of Credit Risk RAROC Models Option Models of Default Risk Summary Appendix 11A Credit Analysis (www.mhhe.com/saunders6e) Appendix 11B Black-Scholes Option Pricing Model (www.mhhe.com/saunders6e) Chapter Twelve Credit Risk: Loan Portfolio and Concentration Risk Introduction Simple Models of Loan Concentration Risk Loan Portfolio Diversification and Modern Portfolio Theory (MPT) KMV Portfolio Manager Model Partial Applications of Portfolio Theory Loan Loss Ratio?Based Models Regulatory Models Summary Appendix 12A Credit Metrics Appendix 12B Credit Risk+ Chapter Thirteen Off-Balance-Sheet Risk Introduction Off-Balance-Sheet Activities and FI Solvency Returns and Risks of Off-Balance-Sheet Activities Loan Commitments Commercial Letters of Credit and Standby Letters of Credit Derivative Contracts: Futures, Forwards, Swaps, and Options Forward Purchases and Sales of When-Issued Securities Loans Sold Non?Schedule L Off-Balance-Sheet Risks Settlement Risk Affiliate Risk The Role of OBS Activities in Reducing Risk Summary Appendix 13A A Letter of Credit Transaction (www.mhhe.com/saunders6e) Chapter Fourteen Foreign Exchange Risk Introduction Foreign Exchange Rates and Transactions Foreign Exchange Rates Foreign Exchange Transactions Sources of Foreign Exchange Risk Exposure Foreign Exchange Rate Volatility and FX Exposure Foreign Currency Trading FX Trading Activities The Profitability of Foreign Currency Trading Foreign Asset and Liability Positions The Return and Risk of Foreign Investments Risk and Hedging Multicurrency Foreign Asset?Liability Positions Interaction of Interest Rates, Inflation, and Exchange Rates Purchasing Power Parity Interest Rate Parity Theorem Summary Chapter Fifteen Sovereign Risk Introduction Credit Risk versus Sovereign Risk Debt Repudiation versus Debt Rescheduling Country Risk Evaluation Outside Evaluation Models Internal Evaluation Models Debt Service Ratio (DSR) Import Ratio (IR) Investment Ratio (INVR) Variance of Export Revenue (VAREX) Domestic Money Supply Growth (MG) Using Market Data to Measure Risk: The Secondary Market for LDC Debt Summary Appendix 15A Mechanisms for Dealing with Sovereign Risk Exposure Chapter Sixteen Technology and Other Operational Risks Introduction What Are the Sources of Operational Risk? Technological Innovation and Profitability The Impact of Technology on Wholesale and Retail Financial Service Production Wholesale Financial Services Retail Financial Services The Effect of Technology on Revenues and Costs Technology and Revenues Technology and Costs Testing for Economies of Scale and Economies of Scope The Production Approach The Intermediation Approach Empirical Findings on Cost Economies of Scale and Scope and Implications for Technology Expenditures Economies of Scale and Scope and X-Inefficiencies Technology and the Evolution of the Payments System Risks That Arise in an Electronic Payment System Other Operational Risks Regulatory Issues and Technology and Operational Risks Summary Chapter Seventeen Liquidity Risk Introduction Causes of Liquidity Risk Liquidity Risk at Depository Institutions Liability-Side Liquidity Risk Asset-Side Liquidity Risk Measuring a DI?s Liquidity Exposure Liquidity Risk, Unexpected Deposit Drains, and Bank Runs Bank Runs, the Discount Window, and Deposit Insurance Liquidity Risk and Property?Casualty Insurers Investment Funds Summary Appendix 17A Sources and Uses of Funds Statements, Bank of America, December 2005 (www.mhhe.com/saunders6e) PART THREE MANAGING RISK Chapter Eighteen Liability and Liquidity Management Introduction Liquid Asset Management Monetary Policy Implementation Reasons Taxation Reasons The Composition of the Liquid Asset Portfolio Return-Risk Trade-Off for Liquid Assets The Liquid Asset Reserve Management Problem for U.S. Depository Institutions Undershooting/Overshooting of the Reserve Target Managing Liquid Assets Other than Cash Liability Management Funding Risk and Cost Choice of Liability Structure Demand Deposits Interest-Bearing Checking (NOW) Accounts Passbook Savings Money Market Deposit Accounts (MMDAs) Retail Time Deposits and CDs Wholesale CDs Federal Funds Repurchase Agreements (RPs) Other Borrowings Liquidity and Liability Structures for U.S. Depository Institutions Liability and Liquidity Risk Management in Insurance Companies Liability and Liquidity Risk Management in Other FIs Summary Appendix 18A Federal Reserve Requirement Accounting (www.mhhe.com/saunders6e) Appendix 18B Bankers Acceptances and Commercial Paper as a Source of Financing (www.mhhe.com/saunders6e) Chapter Nineteen Deposit Insurance and Other Liability Guarantees Introduction Bank and Thrift Guaranty Funds The Causes of the Depository Fund Insolvencies The Financial Environment Moral Hazard Panic Prevention versus Moral Hazard Controlling Depository Institution Risk Taking Stockholder Discipline Depositor Discipline Regulatory Discipline Non-U.S. Deposit Insurance Systems The Discount Window Deposit Insurance versus the Discount Window The Discount Window Other Guaranty Programs National Credit Union Administration Property?Casualty and Life Insurance Companies The Securities Investor Protection Corporation The Pension Benefit Guaranty Corporation Summary Appendix 19A Calculation of Deposit Insurance Premiums Appendix 19B FDIC Press Releases of Bank Failures (www.mhhe.com/saunders6e) Appendix 19C Deposit Insurance Schemes for Commercial Banks in Various Countries (www.mhhe.com/saunders6e) Chapter Twenty Capital Adequacy Introduction Capital and Insolvency Risk Capital The Market Value of Capital The Book Value of Capital The Discrepancy between the Market and Book Values of Equity Arguments against Market Value Accounting Capital Adequacy in the Commercial Banking and Thrift Industry Actual Capital Rules The Capital?Assets Ratio (or Leverage Ratio) Risk-Based Capital Ratios Calculating Risk-Based Capital Ratios Capital Requirements for Other FIs Securities Firms Life Insurance Property?Casualty Insurance Summary Appendix 20A Internal Ratings?Based Approach to Measuring Credit Risk?Adjusted Assets Chapter Twenty-One Product Diversification Introduction Risks of Product Segmentation Segmentation in the U.S. Financial Services Industry Commercial and Investment Banking Activities Banking and Insurance Commercial Banking and Commerce Nonbank Financial Service Firms and Commerce Activity Restrictions in the United States versus Other Countries Issues Involved in the Diversification of Product Offerings Safety and Soundness Concerns Economies of Scale and Scope Conflicts of Interest Deposit Insurance Regulatory Oversight Competition Summary Appendix 21A EU and G-10 Countries: Regulatory Treatment of the Mixing of Banking, Securities, and Insurance Activities and the Mixing of Banking and Commerce (www.mhhe.com/saunders6e) Chapter Twenty-Two Geographic Expansion Introduction Domestic Expansions Regulatory Factors Impacting Geographic Expansion Insurance Companies Thrifts Commercial Banks Cost and Revenue Synergies Impacting Domestic Geographic Expansion by Merger and Acquisition Cost Synergies Revenue Synergies Merger Guidelines for Acceptability Other Market- and Firm-Specific Factors Impacting Domestic Geographic Expansion Decisions The Success of Domestic Geographic Expansions Investor Reaction Postmerger Performance Global and International Expansions U.S. Banks Abroad Foreign Banks in the United States Advantages and Disadvantages of International Expansion Advantages Disadvantages Summary Chapter Twenty-Three Futures and Forwards Introduction Forward and Futures Contracts Spot Contracts Forward Contracts Futures Contracts Forward Contracts and Hedging Interest Rate Risk Hedging Interest Rate Risk with Futures Contracts Microhedging Macrohedging Routine Hedging versus Selective Hedging Macrohedging with Futures The Problem of Basis Risk Hedging Foreign Exchange Risk Forwards Futures Estimating the Hedge Ratio Hedging Credit Risk with Futures and Forwards Credit Forward Contracts and Credit Risk Hedging Futures Contracts and Catastrophe Risk Futures and Forward Policies of Regulators Summary Appendix 23A Interest Rate Futures Quotes from The Wall Street Journal Online Appendix 23B Microhedging with Futures (www.mhhe.com/saunders6e) Chapter Twenty-Four Options, Caps, Floors, and Collars Introduction Basic Features of Options Buying a Call Option on a Bond Writing a Call Option on a Bond Buying a Put Option on a Bond Writing a Put Option on a Bond Writing versus Buying Options Economic Reasons for Not Writing Options Regulatory Reasons Futures versus Options Hedging The Mechanics of Hedging a Bond or Bond Portfolio Hedging with Bond Options Using the Binomial Model Actual Bond Options Using Options to Hedge Interest Rate Risk on the Balance Sheet Using Options to Hedge Foreign Exchange Risk Hedging Credit Risk with Options Hedging Catastrophe Risk with Call Spread Options Caps, Floors, and Collars Caps Floors Collars Caps, Floors, Collars, and Credit Risk Summary Appendix 24A Black-Scholes Option Pricing Model (www.mhhe.com/saunders6e) Appendix 24B Microhedging with Options (www.mhhe.com/saunders6e) Chapter Twenty-Five Swaps Introduction Swap Markets Interest Rate Swaps Realized Cash Flows on an Interest Rate Swap Macrohedging with Swaps Currency Swaps Fixed-Fixed Currency Swaps Fixed-Floating Currency Swaps Credit Swaps Total Return Swaps Pure Credit Swaps Swaps and Credit Risk Concerns Netting and Swaps Payment Flows Are Interest and Not Principal Standby Letters of Credit Summary Appendix 25A Setting Rates on an Interest Rate Swap Chapter Twenty-Six Loan Sales Introduction The Bank Loan Sales Market Definition of a Loan Sale Types of Loan Sales Types of Loan Sales Contracts Trends in Loan Sales The Buyers and the Sellers Why Banks and Other FIs Sell Loans Reserve Requirements Fee Income Capital Costs Liquidity Risk Factors Affecting Loan Sales Growth Access to the Commercial Paper Market Customer Relationship Effects Legal Concerns BIS Capital Requirements Market Value Accounting Asset Brokerage and Loan Trading Government Loan Sales Credit Ratings Purchase and Sale of Foreign Bank Loans Summary Chapter Twenty-Seven Securitization Introduction The Pass-Through Security GNMA FNMA FHLMC The Incentives and Mechanics of Pass-Through Security Creation Prepayment Risk on Pass-Through Securities Prepayment Models Government Sponsorship and Oversight of FNMA and Freddie Mac The Collateralized Mortgage Obligation (CMO) Creation of CMOs Class A, B, and C Bond Buyers Other CMO Classes The Mortgage-Backed Bond (MBB) Innovations in Securitization Mortgage Pass-Through Strips Securitization of Other Assets Can All Assets Be Securitized? Summary Appendix 27A Fannie Mae and Freddie Mac Balance Sheets (www.mhhe.com/saunders6e) INDEX
Library of Congress Subject Headings for this publication:
Financial institutions -- United States -- Management.
Risk management -- United States.
Financial services industry -- United States -- Management.