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PARTI

CHAPTER 1

CHAPTER 2

CHAPTER 3

PART 2

CHAPTER 4

CHAPTER 5

CHAPTER 6

CHAPTER 7

PART 3

CHAPTER 8

CHAPTER 9

CHAPTER 10

CHAPTER 11

PART 4

CHAPTER

CHAPTER

CHAPTER

PART 5

CHAPTER

CHAPTER

CHAPTER

PART 6

CHAPTER

CHAPTER

CHAPTER

CHAPTER

12

13

14

15,

16

17

18

19

20

21j

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FINANCIAL INSTITUTIONS 1

A modern financial system: an overview 4

Commercial banks 44

Non-bank financial institutions 93

EQUITY MARKETS 135

The stock exchange and the corporation 138

Corporations issuing equity in the share market 167

Investors in the share market 197

Forecasting share price movements 230

THE CORPORATE DEBT MARKET 261

Mathematics of finance: an introduction to

basic concepts and calculations 264

Short-term debt 292

Medium- to long-term debt : 321

International debt markets 355

GOVERNMENT DEBT, MONETARY POLICY,THE PAYMENTS SYSTEM AND INTEREST RATES 391

Government debt, monetary policy and

the payments system 394

An intrpduction to interest rate determination and forecasting 426

Interest rate risk measurement 461

THE FOREIGN EXCHANGE MARKET 493

Foreign exchange: the structure and operation of the FX market 496

Foreign exchange: factors that influence the exchange rate 524

Foreign exchange: risk identification and management 551

DERIVATIVE MARKETS AND RISK MANAGEMENT 579

An introduction to risk management and derivatives 582

Fu.tures contracts and forward rate agreements 612

Options 644

Interest rate swaps, cross-currency swaps and credit default swaps 683

CONTENTSPreface xivAbout the authors xvAcknowledgments xviHighlights of the seventh edition xviiiText at a glance xx

E-student xxiiE-instructor. xxiiiExploring finance on the web xxivCareers in finance xxvii

PARTI FINANCIAL INSTITUTIONS

CHAPTER 1 A MODERN FINANCIAL SYSTEM: AN OVERVIEW 41.1 Functions of a financial system 71.2 Financial institutions 91.3 Financial instruments 121.4 Financial markets 151.5 Flow of funds, market relationships and stability 29Financial news case study 31Summary 32Extended learning A: Globalisation of the financial markets 34Extended learning B: The impact of the Asian financial crisis on thefinancial system 36Extended learning C: The global financial crisis .'•. 38

.-Key terms 40Questions 41

CHAPTER 2 COMMERCIAL BANKS 442.1 The main activities of commercial banking 462.2 Sources of funds 472.3 Uses of funds « 512.4 Off-balance-sheet business <. 562.5 Regulation and prudential supervision of commercial banks 592.6 A background to the capital adequacy standards 622.7 Basel II capital accord 632.8 Liquidity management and other supervisory controls 74Financial news case study 78Summary 79Extended learning A: The standardised approach to credit risk 80Extended learning B: Business continuity risk management 83Extended learning C: Corporate governance and ethics 87Key terms '-'. : 89Questions 89

CONTENTS IN FULL (CONTINUED)

CHAPTER 3 NON-BANK FINANCIAL INSTITUTIONS 933.1 Investment banks and merchant banks 953.2 Managed funds 1013.3 Cash management trusts 1053.4 Public unit trusts 1063.5 Superannuation funds 1083.6 Life insurance offices 1133.7 General insurance offices 1173.8 Hedge funds 1193.9 Finance companies and general financiers 1203.10 Building societies 1223.11 Credit unions 1233.12 Export finance corporations 124Financial news case study 125Summary 725Extended learning: Project finance and structured finance .' 727Key terms 757Questions 752

PART 2 EQUITY MARKETS 135

CHAPTER 4 THE STOCK EXCHANGE AND THE CORPORATION 1384.1 The nature of a corporation 1404.2 The stock exchange 1434.3 The primary market role of a stock exchange...., 1444.4 The secondary market role of a stock exchange 1464.5 The managed product and derivative product roles of a

p stock exchange 1484.6 The interest rate market role of a stock exchange ....1534.7 The trading and settlement roles of a stock exchange 154

; 4.8 The information role of a stock exchange 157\ 4.9 The regulatory role of a stock exchange 158

4.10 The private equity market 159Financial news case study 760Summary 767Key terms , 164Questions : 764

CONTENTS IN FULL (CONTINUED)

CHAPTER 5 CORPORATIONS ISSUING EQUITY IN THESHARE MARKET 1675.1 The investment decision: capital budgeting 1695.2 The financing decision: equity, debt and risk 1735.3 Initial public offering 1765.4 Listing a business on a stock exchange 1795.5 Equity-funding alternatives for listed companies 181Financial news case study •.•. 187Summary 188Extended learning: Australian Securities Exchange (ASX)listing rule requirements 790Key terms 795Questions 794

CHAPTER 6 INVESTORS IN THE SHARE MARKET 1976.1 Share-market investment 1996.2 Buying and selling shares 2026.3 Taxation 2046.4 Financial performance indicators :...2076.5 Pricing of shares 2136.6 Stock-market indices and published share information 218

- Financial news case study 223Summary 224Key terms 226Questions : 227

CHAPTER 7 FORECASTING SHARE PRICE MOVEMENTS 2307.1 Fundamental analysis: thfe top-down approach 2327.2 Fundamental analysis: the bottom-up approach 2387.3 Technical analysis 2407.4 Electronic trading : 2487.5 The random walk, efficient market and behavioural finance

hypotheses 250Financial news case study 255Summary 255

Key terms 257Questions 258

PART 3 THE CORPORATE DEBT MARKET 261

CHAPTER 8 MATHEMATICS QF FINANCE: AN INTRODUCTION TOBASIC CONCEPTS AND CALCULATIONS 2648.1 Simple interest 2668.2 Compound interest 274Financial news case study 286

CONTENTS IN FULL (CONTINUED)

Summary 287Key terms 289Questions 289

CHAPTER 9 SHORT-TERM DEBT 2929.1 Trade credit 2949.2 Bank overdrafts 2969.3 Commercial bills 2979.4 Calculations: discount securities 3039.5 Promissory notes 3089.6 Negotiable certificates of deposit 3119.7 Inventory finance, accounts receivable financing and factoring 312Financial news case study 575Summary 575Key terms 577Questions J7S

CHAPTER 10 MEDIUM- TO LONG-TERM DEBT 32110.1 Term loans or fully drawn advances >. 32310.2 Mortgage finance 32910.3 The bond market: debentures, unsecured notes and

subordinated debt 33210.4 Calculations: fixed-interest securities 33710.5 Leasing 341Financial news case study 345Summary •/. 346Extended learning: Securitisation 347Key terms 350Questions •. '. 557

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CHAPTER 11 INTERNATIONAL DEBT MARKETS 35511.1 The euromarkets 35711.2 Eurocurrency market 36011.3 Euronote market 36211.4 Eurobond market 36611.5 Markets in the USA '. 37211.6 Credit rating agencies 376Financial news case study 379Summary 380Extended learning A: Novation, subparticipation and transferable loan

' ^certificates 382• Extended learning B: Convertible bonds and warrants 383

Extended learning C: US medium-term notes 384Extended learning D: Standard & Poor's credit rating definitions 385

- Key terms 387Questions '.-.-- 387

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CONTENTS IN FULL (CONTINUED)

PART 4 GOVERNMENT DEBT, MONETARY POLICY, THEPAYMENTS SYSTEM AND INTEREST RATES 391

CHAPTER 12 GOVERNMENT DEBT, MONETARY POLICY ANDTHE PAYMENTS SYSTEM 39412.1 The Commonwealth government borrowing requirement 39612.2 Commonwealth government securities 39912.3 State government securities 40812.4 Monetary policy 40912.5 The payments system 414Financial news case study 479Summary 420

s Extended learning: Fixed-coupon Treasury bonds: Price calculationusing the Australian Office of Financial Management (AOFM) formula 422Key terms 423Questions 423

CHAPTER 13 AN INTRODUCTION TO INTERESTRATE DETERMINATION AND FORECASTING 42613.1 The macroeconomic context of interest rate determination 428

. . -—13.2 The loanable funds approach to interest rate determination 43213.3 The term structure of interest rates 44013.4 The risk structure of interest rates 449Financial news case study •. 452Summary 453..Extended learning: The yield curt/e and expectations theory calculations 454Key terms 457Questions 458

CHAPTER 14 INTEREST RATE RISK MEASUREMENT 46114.1 Interest rate risk 46314.2 Exposure management systems 46414.3 Assets re-priced before liabilities principle 46714.4 Pricing financial securities 46814.5 Re-pricing gap analysis 47114.6 Duration 47414.7 Convexity .' 48014.8 Interest rate risk management techniques 483Financial news case study 485Summary „ < • . . * 486Key terms f. 488Questions .'..* 488

CONTENTS IN FULL (CONTINUED)

PARTS THE FOREIGN EXCHANGE MARKET 493

CHAPTER 15 FOREIGN EXCHANGE: THE STRUCTURE ANDOPERATION OF THE FX MARKET 49615.1 Exchange rate regimes 49815.2 Foreign exchange market participants 49915.3 The operation of the FX market 50315.4 Spot and forward transactions 50415.5 Spot market quotations 50615.6 Forward market quotations 51115.7 European Monetary Union and the FX markets 516Financial news case study 578Summary 579Key terms 527Questions 527

CHAPTER 16 FOREIGN EXCHANGE: FACTORS THAT INFLUENCETHE EXCHANGE RATE \ 52416.1 The FX markets and an equilibrium exchange rate 52616.2 Factors that influence exchange rate movements 53016.3 Measuring exchange rate sensitivity to changes in

economic variables 540Financial news case study 542Summary 543Extended learning: Purchasing power parity. .: 545Key te*rms 547

Questions 548

CHAPTER 17 FOREIGN EXCHANGE: RISK IDENTIFICATION ANDi MANAGEMENT 551

17.1 Foreign exchange risk policy formulation 55317.2 • Measuring transaction exposure 55817.3 Risk management: market-based hedging techniques 56417.4 Risk management: internal hedging techniques 568Financial news case study : 572Summary 573Key terms 574duestions 575

CONTENTS IN FULL (CONTINUED)

PART 6 DERIVATIVE MARKETS AND RBSKMANAGEMENT 579

CHAPTER 18 AN INTRODUCTION TO RISK MANAGEMENT ANDDERIVATIVES i 58218.1 Understanding risk y....::..~T.. 58418.2 The risk management process 58718.3 Futures contracts 59118.4 Forward contracts 59418.5 Option contracts 59618:& Swap contracts. 600Financial news case study 604

"* Summary .'.• 605

Key terms , 607Questions 608

CHAPTER 19 FUTURES CONTRACTS AND FORWARD RATEAGREEMENTS \61219.1' Hedging using futures contracts 61419:2 Main features of a futures transaction 616

. - —19.3- - Futures market instruments 62019:4 Futures market participants 62219.5 Hedging: risk management

using futures 62419.6: Risks in using futures contracts^ for hedging 62919.7 Forward rate agreements .t. 633Financial news case study 637Summary ".. , 638Key terms .•; •/. 640Questions 640

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CHAPTER 20 OPTIONS . 64420.1 The nature of options 64620.2 Option profit and loss payoff profiles 64720.3 The organisation:of the market. ., 65520.4 Factors affecting an option contract premium 66020.5. Option risk management strategies' 665Financial news case study r ".". 677Summary 678Key terms v .«*..* L , 679Questions j 680

CONTENTS IN FULL (CONTINUED)

C H A P T E R 21 INTEREST RATE S W A P S , C R O S S - C U R R E N C Y S W A P SAND CREDIT DEFAULT SWAPS 68321.1 Interest rate swaps 68521.2 Rationale for the existence of interest rate swaps 68921.3 Cross-currency swaps 69321.4 Rationale for the existence of currency swaps 69621.5 Credit default swaps 69821.6 Credit and settlements risk associated with swaps 701Financial news case study 702Summary 703Key terms 705Questions 706

Glossary 777

Index 733

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