An Introduction to Global Financial Markets PDF

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‘The 8th edition of An Introduction to Global Financial Markets is a concise and insightful introduction to the workings of financial markets, products and institutions. This book is essential reading for students and finance professionals who wish to familiarise themselves with the workings of fin...

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‘The 8th edition of An Introduction to Global Financial Markets is a concise and insightful introduction to the workings of financial markets, products and institutions. This book is essential reading for students and finance professionals who wish to familiarise themselves with the workings of financial markets and institutions in an intuitive and yet comprehensive manner.’ Jens Hagendorff, Martin Currie Professor of Finance & Investment, University of Edinburgh Business School, University of Edinburgh, UK ‘This 8th edition of An Introduction to Global Financial Markets by Valdez and Molyneux is a much appreciated guide to better understand contemporary financial markets, institutions and regulators around the globe. Its clear and concise language makes it a valuable asset for both students and practitioners alike. Anyone embarking on an analysis of finance and financial markets against the backdrop of recent and ongoing crises and regulatory responses should resort to this comprehensive yet to-the-point book.’ Michael Koetter, Professor of Banking and Finance, Frankfurt School of Finance and Management, Frankfurt, Germany ‘We are limited as to how many books we can read, but we do have the privilege of the right choice. Presenting the vocational aspects of modern financial markets, without sacrificing the academic rigour is an art that most aim to strike. When this is combined with a very insightful way of the mechanics of global finance, then this becomes a masterpiece that everyone should read. This is what the latest edition of the book An Introduction to Global Financial Markets is all about.’ Dr Sotiris K. Staikouras, Cass Business School, City University London, UK ‘I welcome this well-revised edition of this highly successful book. Its authors combine world-class scholarship with the highest level of real-world knowledge and experience. Their book not surprisingly therefore continues to be a most reliable guide for students that dare to venture into the bewildering (and at times bewitching) landscape of global financial markets.’ Steven Ongena, Professor of Banking, University of Zurich, Swiss Finance Institute, Switzerland and CEPR, UK ‘This is an excellent introductory text, full of information, written with great clarity and in a style that will make it readily accessible and understandable for students.’ Graham Partington, Chair of the Finance Discipline, University of Sydney, Australia ‘The eighth edition of An Introduction to Global Financial Markets is a must-read for those beginning to study finance and an essential reference for advanced students of the topic. The coverage of the recent financial crisis is fantastic and provides a thorough update of all the data, markets, institutions and financial instruments that played a role in the crisis.’ Allen N. Berger, H. Montague Osteen, Jr., Professor in Banking and Finance, Carolina Distinguished Professor, Moore School of Business, University of South Carolina, US

‘The new edition of Valdez and Molyneux’s book An Introduction to Global Financial Markets is essential reading for anyone interested in understanding the functioning of banking and financial sectors. The eighth edition offers another substantial update, making the discussion of current topics really up to date and useful to understand the momentous changes in banking and financial markets. I highly recommend it.’ Barbara Casu, Reader in Banking, Cass Business School, City University London, UK ‘This updated edition remains essential reading for anyone studying how global financial markets operate and, more importantly, looking for insights as to how they may work in the future. An indispensable resource for all finance professionals.’ Simon Thompson, Chief Executive, Chartered Banker Institute, UK ‘Having taught courses on financial markets and institutions over the last 15 years, this book has become the perfect tool to provide an attractive and updated picture of todays’ financial system structure and challenges not only to students but also for practitioners and all readers interested in knowing more about the financial side of the world. It is a fascinating and thoroughly readable guide.’ Francisco Rodriguez-Fernandez, Professor of Economics and Finance, University of Granada, Spain ‘Valdez and Molyneux provide a comprehensive and accessible analysis of the evolution of global financial markets. Through careful use of background references and data, the authors provide an extensive coverage of historical and recent events and the resultant impact on the global financial system. This book is essential reading for those wishing to get to grips with the structure and workings of the modern financial system.’ John O.S. Wilson, Professor of Banking & Finance and Director for the Centre of Responsible Banking & Finance, University of St Andrews, UK

An IntroductIon to

Global Financial Markets 8th edition

Stephen Valdez & Philip Molyneux

© Stephen Valdez and Philip Molyneux 2016 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No portion of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, Saffron House, 6–10 Kirby Street, London EC1N 8TS. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988. First edition published 1993 as An Introduction to Western Financial Markets Second edition 1997 Third edition 2000 Fourth edition 2003 Fifth edition 2007 Sixth edition 2010 Seventh edition 2013 This edition 2016 Published by PALGRAVE Palgrave in the UK is an imprint of Macmillan Publishers Limited, registered in England, company number 785998, of 4 Crinan Street, London N1 9XW. Palgrave Macmillan in the US is a division of St Martin’s Press LLC, 175 Fifth Avenue, New York, NY 10010. Palgrave is a global imprint of the above companies and is represented throughout the world. Palgrave® and Macmillan® are registered trademarks in the United States, the United Kingdom, Europe and other countries. ISBN 978–1–137–49755–0 This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. Logging, pulping and manufacturing processes are expected to conform to the environmental regulations of the country of origin. A catalogue record for this book is available from the British Library.

short contents List of Figures List of Tables List of Boxes Preface Companion Website Acknowledgements Abbreviations

xvi xviii xx xxii xxv xxvi xxix

Part 1: Introduction

1

1

2

The Money Merry-go-round

Part 2: Banking 2 3 4 5 6

11

Banking Background The Role of the Central Bank Commercial Banking Investment Banking Regulation

12 49 69 103 120

Part 3: Securities Markets and Investment Companies

145

7 8 9

146 194 237

The Money and Bond Markets Equity Markets Hedge Funds and Private Equity

Part 4: Financial Crisis

263

10 Financial Crisis

264

Part 5: Foreign Exchange, Europe and the Eurozone

307

11 Foreign Exchange 12 Europe and the Eurozone

308 338

Part 6: Derivative Products

379

13 Traded Options 14 Financial Futures 15 Other Derivative Products

380 397 414

Part 7: Emerging and Growth-leading Economies (EAGLEs)

437

16 Emerging and Growth-leading Economies (EAGLEs)

438

Part 8: Trends in the Global Financial Markets

469

17 Key Trends

470

Glossary Index

493 508

v

contents List of Figures List of Tables List of Boxes Preface Companion Website Acknowledgements Abbreviations

xvi xviii xx xxii xxv xxvi xxix

Part 1: Introduction

1

1

2 2 2 3 4 5 5 5 5 6 8 9 9 9

The Money Merry-go-round RAIsOn D’êTRE OF THE MARKETs Lenders Borrowers securities RAIsInG CAPITAL Bank Loans Bonds Equity Gearing/Leverage COnCLusIOn suMMARy REVIsIOn QuEsTIOns/AssIGnMEnTs FuRTHER READInG

Part 2: Banking

11

2

12 12 15 16 16 17 18 18 20 21 22 23 24 25 25 26 27 27

Banking Background HIsTORy BAnKInG suPERVIsIOn TyPEs OF BAnK: DEFInITIOns Central Banks Commercial Banks Merchant/Investment Banks savings Banks Cooperative Banks Mortgage Banks Giro Banks Credit unions Islamic Banks OTHER BAnKInG TERMInOLOGy Clearing Banks state or Public Banks International Banking shadow Banking

vi

ConTEnTS

vii

A BAnK’s BALAnCE sHEET THE CREATIOn OF CREDIT Banking Depends on Confidence The Money supply Liquidity Ratios CAPITAL RATIO The Basel Committee Basel III European Capital Regulation Increasing Capital Ratio CEnTRAL BAnK REPORTInG THE Eu’s sECOnD BAnKInG DIRECTIVE MAjOR WORLD BAnKs suMMARy REVIsIOn QuEsTIOns/AssIGnMEnTs REFEREnCEs FuRTHER READInG Appendix 1: Top us bank mergers and acquisitions

27 29 30 30 32 32 33 36 37 38 39 40 41 45 46 46 47 48

3

The Role of the Central Bank HIsTORy OF THE MAjOR CEnTRAL BAnKs Brazil China France Germany India japan Russia united Kingdom united states The European Central Bank CEnTRAL BAnK ACTIVITIEs supervision of the Banking system Monetary Policy Banknotes Banker to the Other Banks Banker to the Government Raising Money for the Government Controlling the nation’s Currency Reserves Acting as Lender of Last Resort Liaison with International Bodies THE POsITIOn OF CEnTRAL BAnKs TODAy suMMARy REVIsIOn QuEsTIOns/AssIGnMEnTs REFEREnCE FuRTHER READInG

49 49 49 49 49 50 50 50 51 51 52 54 54 55 56 57 60 61 61 62 63 64 65 67 68 68 68

4

Commercial Banking InTRODuCTIOn

69 69

viii

ConTEnTS

RETAIL BAnKInG Types of service Money Banking: Deposits new Payments Technologies Loans Other services Delivery Channels Clearing systems Key Retail Banking Issues use of IT WHOLEsALE BAnKInG uncommitted Facilities Committed Facilities syndicated Facilities The Loan Agreement WHOLEsALE BAnKInG IssuEs suMMARy REVIsIOn QuEsTIOns/AssIGnMEnTs REFEREnCEs FuRTHER READInG

69 69 70 72 74 76 78 82 84 90 91 91 92 94 98 100 101 102 102 102

5

Investment Banking InTRODuCTIOn InVEsTMEnT BAnKInG Accepting Corporate Finance securities Trading Investment Management Loan Arrangement Foreign Exchange Miscellaneous Activities InVEsTMEnT BAnKs AnD THE CREDIT CRIsIs REGuLATIOn sHADOW BAnKInG suMMARy REVIsIOn QuEsTIOns/AssIGnMEnTs REFEREnCE FuRTHER READInG

103 103 103 103 106 110 111 112 112 112 113 114 115 118 118 119 119

6

Regulation AFTER THE CRIsIs FREQuEnCy OF CRIsEs AnD THEIR COsTs RATIOnALE FOR BAnK REGuLATIOn InFORMATIOn AsyMMETRIEs In BAnKInG AnD FInAnCE GOVERnMEnT sAFETy nET PROBLEMs FOR REGuLATORs THEORIEs OF BAnKInG CRIsEs FEATuREs OF sysTEMIC RIsK What Is ‘systemic Risk’? solvency, Liquidity and Maturities Funding Liquidity and the ‘Domino Effect’

120 120 120 121 122 123 124 125 125 125 126

ConTEnTS

‘Mark to Market’ and Asset Price Effects The ‘Haircut’ spiral systemic Risk: spirals and the Rationale for Regulation THE RIsE OF sysTEMICALLy IMPORTAnT FInAnCIAL InsTITuTIOns (sIFIs) Which Are the sIFIs? Why Worry about Big Institutions? us REGuLATORy REsPOnsE TO THE CRIsIs: DODD-FRAnK ACT 2010 uK REGuLATORy REsPOnsE TO THE CRIsIs EuROPEAn REGuLATORy REsPOnsE InTERnATIOnAL ACTIOn suMMARy REVIsIOn QuEsTIOns/AssIGnMEnTs REFEREnCEs FuRTHER READInG

Part 3: Securities Markets and Investment Companies 7

The Money and Bond Markets THE RATE OF InTEREsT Risk Maturity Expectations Liquidity supply and Demand Inflation yield Par Values Interest yield Gross Redemption yield Accrued Interest CREDIT RATInGs DOMEsTIC MOnEy MARKETs Call Money The Interbank Market Money Market securities CEnTRAL BAnK ROLE DOMEsTIC BOnD MARKETs Government Bonds (sovereigns) Local Authority/Public sector Bonds Mortgage and Asset-backed Bonds Corporate Bonds Hybrid Bonds Foreign Bonds junk Bonds (High-yield Debt) Islamic Bonds InTERnATIOnAL MARKETs Background: Eurocurrencies The syndicated Loan Market The International Debt Crisis The Eurobond Market

ix 127 127 128 128 129 129 133 135 135 141 142 143 143 144

145 146 146 146 147 148 148 148 149 149 149 150 150 152 153 155 155 155 158 161 163 165 168 168 171 174 175 176 177 177 177 179 179 183

x

ConTEnTS

8

Coupon stripping Other Variations Medium-term notes The Money Markets Repos Participants and Top Traders suMMARy REVIsIOn QuEsTIOns/AssIGnMEnTs REFEREnCEs FuRTHER READInG Appendix 1: Announcement of result of a uK bid price auction for government bonds

185 186 188 188 188 189 191 192 192 192

Equity Markets HIsTORy OF AssOCIATIOns FOR TRADInG THE ROLE OF A sTOCK ExCHAnGE sTOCKs AnD sHAREs EFFICIEnT MARKETs InDICEs THE LIsTInG PROCEss: GOInG PuBLIC RIGHTs IssuEs sCRIP IssuEs, sPLITs AnD sCRIP DIVIDEnDs InTERnATIOnAL EQuITy TRADInG In THE MEDIuM AnD LOnG Run: WHO OWns sHAREs? small Investors versus Institutions Pension Funds: Funding versus unfunding Equity Investment share Buy-backs Mutual Funds Active versus Passive Management Custodians TRADInG In THE sHORT Run: DEALInG sysTEMs Order-driven systems Quote-driven systems Hybrid systems Interdealer Brokers stock Borrowing and Lending Bought Deals/Block Trades THE TRADInG PROCEss: CLEARInG AnD sETTLEMEnT sECOnD MARKETs AnALysTs’ RATIOs us sTOCK MARKET: THE nEW PARADIGM AnD THE BuRsTInG OF THE DOT-COM AnD sECuRITIzATIOn BuBBLE Eu RuLEs Investment services Directive Markets in Financial Instruments Directive Capital Requirements Directive Mergers and Acquisitions CHALLEnGEs TO TRADITIOnAL sTOCK ExCHAnGEs

194 194 195 196 198 199 202 204 206 207

193

208 208 209 212 213 214 217 218 219 219 221 223 224 224 225 226 227 227 229 230 230 230 232 232 233

ConTEnTS

9

xi

suMMARy REVIsIOn QuEsTIOns/AssIGnMEnTs REFEREnCEs FuRTHER READInG

235 236 236 236

Hedge Funds and Private Equity InTRODuCTIOn Hedge Funds Private Equity HEDGE FunDs Leverage and short selling strategies Range and Activities of Hedge Funds Investors Returns Regulation PRIVATE EQuITy Investors Leverage Hedge Funds and Private Equity Coming Closer Profits on Private Equity suMMARy REVIsIOn QuEsTIOns/AssIGnMEnTs REFEREnCEs FuRTHER READInG

237 237 238 239 242 243 245 248 250 251 252 254 255 257 258 258 259 260 260 261

Part 4: Financial Crisis 10 Financial Crisis InTRODuCTIOn WHAT WEnT WROnG? Macroeconomic Factors Microeconomic Factors sTAGEs OF THE CRIsIs sECuRITIzATIOn AnD HOW IT FuELLED THE CRIsIs start of securitization Role of the us Government-sponsored Enterprises sub-prime Lending Modern securitization Business securitizing the securitizations: Recent Developments The Role of Rating Agencies and Monoline Insurers The Impact of securitization and its Future CREDIT CRIsIs In THE us CREDIT CRIsIs In EuROPE united Kingdom switzerland Iceland Germany spain Belgium, the netherlands and Luxembourg Other European Countries

263 264 264 265 265 266 268 268 268 272 273 273 276 277 279 282 286 286 288 289 290 291 291 292

xii

ConTEnTS

CREDIT CRIsIs In jAPAn CREDIT CRIsIs In CHInA AnD InDIA WHAT HAVE WE LEARnED FROM THE CRIsIs? Bank Recapitalizations and Cleansing of Bank Balance sheets Capital and Liquidity Regulation scope of Regulation, and separation of Bank Functions systemic Risk Credit Rating Agencies Credit Derivative Markets Cross-border supervision and Regulation suMMARy REVIsIOn QuEsTIOns/AssIGnMEnTs REFEREnCEs FuRTHER READInG

Part 5: Foreign Exchange, Europe and the Eurozone 11 Foreign Exchange InTRODuCTIOn The Market Buyers and sellers Bank Profits WHAT DETERMInEs ExCHAnGE RATEs? BRETTOn WOODs Exchange Rate stability International Monetary Fund The World Bank FLOATInG RATEs EuROPEAn ECOnOMIC AnD MOnETARy unIOn FOREIGn ExCHAnGE RIsK FOR CORPORATEs Types of Risk Transaction Risk: Forward Rates Transaction Risk: Options FOREIGn ExCHAnGE DEALInG Quotations Cross-rates Foreign Exchange swaps Brokers settlement ARBITRAGE CEnTRAL BAnK suRVEys WHy LOnDOn? suMMARy REVIsIOn QuEsTIOns/AssIGnMEnTs REFEREnCEs FuRTHER READInG Appendix 1: Foreign exchange turnover by currency pairs, daily averages in April 2004, 2007 and 2010, in billions of usD

294 295 296 297 298 299 300 300 300 301 302 304 304 304

307 308 308 308 308 310 310 313 313 313 314 315 318 319 319 320 322 325 325 326 326 328 329 331 332 334 334 335 335 336 337

ConTEnTS

12 Europe and the Eurozone InTRODuCTIOn HIsTORy OF THE EuROPEAn unIOn Early History 1945 The Council of Europe The European Coal and steel Community (1952–2002) ‘All Roads Lead to Rome’ The European Economic Community (1958–93) Wider Membership The de Gaulle stalemate The European Council The single European Act European Free Trade Area The Maastricht, Amsterdam and nice Treaties THE InsTITuTIOns OF THE EuROPEAn unIOn The European Council The Council of Ministers The European Commission The European Parliament Ecofin The European Central Bank (ECB) sTEPs TO EMu AnD THE CREATIOn OF THE EuRO The Werner Report European Monetary system Changes to the ERM The Delors Plan The Maastricht Treaty EMu The stability and Growth Pact ERM II next Members? EMu statistics Payment systems EMu: The Benefits The Counterarguments The uK Position EuROzOnE sOVEREIGn DEBT CRIsIs solving the sovereign Debt Crisis EuROPEAn BAnKInG unIOn EuROPEAn COMMIssIOn DIRECTIVEs IMPACTInG THE FInAnCIAL sECTOR BAnKInG TREnDs suMMARy REVIsIOn QuEsTIOns/AssIGnMEnTs FuRTHER READInG

xiii 338 338 338 338 339 339 340 340 341 342 342 343 343 344 344 346 346 346 346 346 347 347 350 350 350 351 351 351 352 353 355 355 356 356 357 359 360 362 366 368 371 373 376 378 378

xiv

ConTEnTS

Part 6: Derivative Products

379

13 Traded Options DERIVATIVE PRODuCTs TRADED OPTIOns: EQuITIEs Calls and Puts Option Writers Trading Options Intrinsic Value and Time Value Calculation of the Premium Exercise or Trade? Other Terminology Options on Indices TRADED OPTIOns: OTHER OPTIOns Currencies Bonds Interest Rates OPTIOn sTRATEGIEs suMMARy REVIsIOn QuEsTIOns/AssIGnMEnTs FuRTHER READInG

380 380 381 381 382 383 384 385 387 388 388 391 391 391 392 393 396 396 396

14 Financial Futures FuTuREs TRADInG Background Hedgers versus speculators Commodity Futures Financial Futures Index Futures Bond Futures Interest Rates Currency Futures some Problems of Futures Exchanges Open Outcry or Computers? Contract Volumes suMMARy REVIsIOn QuEsTIOns/AssIGnMEnTs REFEREnCE FuRTHER READInG

397 397 397 397 398 400 404 406 407 408 409 409 410 412 412 412 413

15 Other Derivative Products InTRODuCTIOn FORWARD RATE AGREEMEnTs sWAPs Comparative Advantage Interest Rate swaps Making a Market in swaps users of swaps swaps and Futures Other swaps swapnotes and the swaps yield Curve

414 414 414 416 416 417 418 419 420 42...