@PROFDOCDIGITALLIBRARIES
SOLUTION MANUAL
Financial Markets and Institutions 8th Edition by Anthony Saunders
Part I
Introduction and Overview of Financial Markets
Chapter One Introduction
I. Chapter Outline
1. Why Study Financial Markets and Institutions? Chapter Overview
PR
2. Overview of Financial Markets
a. Primary Markets versus Secondary Markets
b. Money Markets versus Capital Markets
c. Foreign Exchange Markets
d. Derivative Security Markets
e. Financial Market Regulation
O
3. Overview of Financial Institutions
a. Unique Economic Functions Performed by Financial Institutions
b. Additional Benefits FIs Provide to Suppliers of Funds
FD
c. Economic Functions FIs Provide to the Financial System as a Whole
d. Risks Incurred by Financial Institutions
e. Regulation of Financial Institutions
f. Trends in the United States
4. Globalization of Financial Markets and Institutions
O
Appendix 1A: The Financial Crisis: The Failure of Financial Institutions‘ Specialness
(available through McGraw Hill‘s Connect. Contact your McGraw Hill representative for
more information on making the appendix available to your students).
C
II. Learning Goals
1. Differentiate between primary and secondary markets.
2. Differentiate between money and capital markets.
3. Understand what foreign exchange markets are.
4. Understand what derivative securities markets are.
5. Distinguish between the different types of financial institutions.
6. Know the services financial institutions perform.
7. Know the risks financial institutions face.
8. Appreciate why financial institutions are regulated.
9. Recognize that financial markets are becoming increasingly global.
,@PROFDOCDIGITALLIBRARIES
III. Chapter in Perspective
This chapter has three major sections and one minor section. The text provides a
general overview of the major types of U.S. financial markets, focusing primarily on
terminology and descriptions of the major securities, market structures and regulators.
Market microstructure is not discussed. Foreign exchange transactions are also briefly
introduced. Second, the chapter describes the various types of financial institutions and
explains the risks they face and the services they provide to funds‘ users and funds‘
suppliers. The financial crisis is discussed and the impact of Brexit is considered. The
final section of the chapter provides statistics about the rapid growth of globalization of
both markets and institutions. An appendix covering the details of the financial crisis and
the government intervention programs, including the costs as of late 2009, is available
through McGraw Hill‘s Connect. Contact your McGraw Hill representative for more
information on making the appendix available to your students.
IV. Key Concepts and Definitions to Communicate to Students
PR
Financial markets Primary markets
Initial public offerings (IPO) Secondary markets
Derivative security Liquidity
O
Money markets Over-the-counter (OTC) markets
FD
Capital markets Derivative security markets
Financial institutions Direct transfer
Price risk Indirect transfer
O
Delegated monitor Asset transformers
Diversify Economies of scale
C
Enterprise risk management (ERM)
Appendix terms include:
TARP Federal Reserve Rescue Efforts
Federal Stimulus programs American International Group
FDIC Bank takeovers Other financial initiatives
Other housing initiatives
,V. Teaching Notes
a. Why Study Financial Markets and Institutions?
For an economy to achieve its potential growth rate, mechanisms must exist to
effectively allocate capital (a scarce resource) to the best possible uses while accounting
for the riskiness of the opportunities available. Markets and institutions have been created
to facilitate transfers of funds from economic agents with surplus funds to economic
agents in need of funds. For an economy to maximize its growth potential it must create
methods that attract savers‘ excess funds and then put those funds to the best uses
possible, otherwise idle cash is not used as productively as possible. The funds transfer
should occur at as low a cost as possible to ensure maximum economic growth. Two
competing alternative methods exist: direct and indirect financing. In direct financing the
ultimate funds supplier purchases a claim from the funds demander with or without the
help of an intermediary such as an underwriter. In this case, society relies on primary
markets to initially price the issue and then secondary markets to update the prices and
PR
provide liquidity. Trustees are appointed to monitor contractual obligations of issuers
and instigate enforcement actions for breach of contract terms. In indirect financing, the
funds demander obtains financing from a financial intermediary. The intermediary and
the borrower negotiate the terms and cost. The intermediary obtains funds by offering
different claims to fund suppliers. In this case the intermediary is usually responsible for
monitoring the contractual conditions of the financing agreement and perhaps updating
O
the cost if appropriate.
FD
O
C
, The financial crisis of 2008-2009 reversed a long-term trend of deregulating
financial institutions. Regulatory risk and costs of regulation increased as a result of the
new laws, higher capital requirements and stricter regulatory oversight. A former Federal
Reserve Chair, Alan Greenspan, believed in only minimal regulation and his philosophy
appeared to prevail at many regulatory agencies including the SEC. As discussion leader,
you may wish to point out that it is not clear whether the existing rules would have been
sufficient to prevent the crisis if they had been enforced. Laws and regulations by
themselves are insufficient to ensure proper behavior in any case. Practitioners and
academics also need to emphasize business ethics and individual accountability.
Nevertheless, the financial crisis led to the massive Dodd-Frank bill (Wall Street Reform
and Consumer Protection Act) designed to limit systemic risk and tighten controls on the
institutions that many blame for causing the financial crisis. The ―Volcker Rule‖
prohibited insured intermediaries from engaging in proprietary trading, owning, or
managing a hedge fund and private equity investments. The Volcker rule was only slowly
implemented because banks correctly maintain that many of their proprietary activities
PR
are actually hedges to reduce risk and these are allowed. It is difficult to separate hedging
from speculative based trades. An unintended consequence of the Volcker rule is the
reduction of liquidity in the bond markets as banks reduce their bond trading activities.
Although details are not clear at this time, it is likely the Trump administration will roll
back many Dodd-Frank requirements, including the Volcker rule and the Consumer
Finance Protection Bureau‘s (CFPB) attempts to increase the fiduciary responsibility of
O
investment advisors with respect to conflicts of interest with their clients. In 2018, the
Volker Rule was amended to exempt smaller banks from the full scope of the Volcker
Rule as well as eliminated the presumption that positions held for fewer than 60 days
FD
violated the rule unless bankers proved otherwise. The amendments went into effect in
2019 resulting in bank holdings of derivative securities increasing to $201.32 trillion by
2019.
Maintaining profitability with restricted activities in a continuously evolving,
globally competitive market has been a major challenge to the financial industry. The
O
pace of innovation of new technology, financial products and services has not abated.
Technological advances may change traditional methods of offering financial services at
the wholesale, and perhaps eventually, at the retail level. Job opportunities for finance
students in markets and institutions are likely to continue to improve over the next ten to
C
twenty years as managing risks at intermediaries in increasingly complex and competitive
businesses will grow in importance. For career information you may wish to refer
students to https://dhigroupinc.com/home/default.aspx. The text provides an introductory
examination of the functions and characteristics of markets and risk and profitability
management at major financial institutions in order to help students understand the
workings of the financial system in today‘s global economy.
Growth began to pick up in 2016 and market optimism increased with the election
of the new president. The unemployment rate has fallen very low and while economic
growth has not progressed as rapidly as expected. Bond market issuance continued at a
strong pace, although overall credit provided by banks experienced a delayed growth.
This implies that larger firms have had little difficulty in obtaining credit, but some
smaller firms that rely more on bank lending continue to have difficulty obtaining credit.
SOLUTION MANUAL
Financial Markets and Institutions 8th Edition by Anthony Saunders
Part I
Introduction and Overview of Financial Markets
Chapter One Introduction
I. Chapter Outline
1. Why Study Financial Markets and Institutions? Chapter Overview
PR
2. Overview of Financial Markets
a. Primary Markets versus Secondary Markets
b. Money Markets versus Capital Markets
c. Foreign Exchange Markets
d. Derivative Security Markets
e. Financial Market Regulation
O
3. Overview of Financial Institutions
a. Unique Economic Functions Performed by Financial Institutions
b. Additional Benefits FIs Provide to Suppliers of Funds
FD
c. Economic Functions FIs Provide to the Financial System as a Whole
d. Risks Incurred by Financial Institutions
e. Regulation of Financial Institutions
f. Trends in the United States
4. Globalization of Financial Markets and Institutions
O
Appendix 1A: The Financial Crisis: The Failure of Financial Institutions‘ Specialness
(available through McGraw Hill‘s Connect. Contact your McGraw Hill representative for
more information on making the appendix available to your students).
C
II. Learning Goals
1. Differentiate between primary and secondary markets.
2. Differentiate between money and capital markets.
3. Understand what foreign exchange markets are.
4. Understand what derivative securities markets are.
5. Distinguish between the different types of financial institutions.
6. Know the services financial institutions perform.
7. Know the risks financial institutions face.
8. Appreciate why financial institutions are regulated.
9. Recognize that financial markets are becoming increasingly global.
,@PROFDOCDIGITALLIBRARIES
III. Chapter in Perspective
This chapter has three major sections and one minor section. The text provides a
general overview of the major types of U.S. financial markets, focusing primarily on
terminology and descriptions of the major securities, market structures and regulators.
Market microstructure is not discussed. Foreign exchange transactions are also briefly
introduced. Second, the chapter describes the various types of financial institutions and
explains the risks they face and the services they provide to funds‘ users and funds‘
suppliers. The financial crisis is discussed and the impact of Brexit is considered. The
final section of the chapter provides statistics about the rapid growth of globalization of
both markets and institutions. An appendix covering the details of the financial crisis and
the government intervention programs, including the costs as of late 2009, is available
through McGraw Hill‘s Connect. Contact your McGraw Hill representative for more
information on making the appendix available to your students.
IV. Key Concepts and Definitions to Communicate to Students
PR
Financial markets Primary markets
Initial public offerings (IPO) Secondary markets
Derivative security Liquidity
O
Money markets Over-the-counter (OTC) markets
FD
Capital markets Derivative security markets
Financial institutions Direct transfer
Price risk Indirect transfer
O
Delegated monitor Asset transformers
Diversify Economies of scale
C
Enterprise risk management (ERM)
Appendix terms include:
TARP Federal Reserve Rescue Efforts
Federal Stimulus programs American International Group
FDIC Bank takeovers Other financial initiatives
Other housing initiatives
,V. Teaching Notes
a. Why Study Financial Markets and Institutions?
For an economy to achieve its potential growth rate, mechanisms must exist to
effectively allocate capital (a scarce resource) to the best possible uses while accounting
for the riskiness of the opportunities available. Markets and institutions have been created
to facilitate transfers of funds from economic agents with surplus funds to economic
agents in need of funds. For an economy to maximize its growth potential it must create
methods that attract savers‘ excess funds and then put those funds to the best uses
possible, otherwise idle cash is not used as productively as possible. The funds transfer
should occur at as low a cost as possible to ensure maximum economic growth. Two
competing alternative methods exist: direct and indirect financing. In direct financing the
ultimate funds supplier purchases a claim from the funds demander with or without the
help of an intermediary such as an underwriter. In this case, society relies on primary
markets to initially price the issue and then secondary markets to update the prices and
PR
provide liquidity. Trustees are appointed to monitor contractual obligations of issuers
and instigate enforcement actions for breach of contract terms. In indirect financing, the
funds demander obtains financing from a financial intermediary. The intermediary and
the borrower negotiate the terms and cost. The intermediary obtains funds by offering
different claims to fund suppliers. In this case the intermediary is usually responsible for
monitoring the contractual conditions of the financing agreement and perhaps updating
O
the cost if appropriate.
FD
O
C
, The financial crisis of 2008-2009 reversed a long-term trend of deregulating
financial institutions. Regulatory risk and costs of regulation increased as a result of the
new laws, higher capital requirements and stricter regulatory oversight. A former Federal
Reserve Chair, Alan Greenspan, believed in only minimal regulation and his philosophy
appeared to prevail at many regulatory agencies including the SEC. As discussion leader,
you may wish to point out that it is not clear whether the existing rules would have been
sufficient to prevent the crisis if they had been enforced. Laws and regulations by
themselves are insufficient to ensure proper behavior in any case. Practitioners and
academics also need to emphasize business ethics and individual accountability.
Nevertheless, the financial crisis led to the massive Dodd-Frank bill (Wall Street Reform
and Consumer Protection Act) designed to limit systemic risk and tighten controls on the
institutions that many blame for causing the financial crisis. The ―Volcker Rule‖
prohibited insured intermediaries from engaging in proprietary trading, owning, or
managing a hedge fund and private equity investments. The Volcker rule was only slowly
implemented because banks correctly maintain that many of their proprietary activities
PR
are actually hedges to reduce risk and these are allowed. It is difficult to separate hedging
from speculative based trades. An unintended consequence of the Volcker rule is the
reduction of liquidity in the bond markets as banks reduce their bond trading activities.
Although details are not clear at this time, it is likely the Trump administration will roll
back many Dodd-Frank requirements, including the Volcker rule and the Consumer
Finance Protection Bureau‘s (CFPB) attempts to increase the fiduciary responsibility of
O
investment advisors with respect to conflicts of interest with their clients. In 2018, the
Volker Rule was amended to exempt smaller banks from the full scope of the Volcker
Rule as well as eliminated the presumption that positions held for fewer than 60 days
FD
violated the rule unless bankers proved otherwise. The amendments went into effect in
2019 resulting in bank holdings of derivative securities increasing to $201.32 trillion by
2019.
Maintaining profitability with restricted activities in a continuously evolving,
globally competitive market has been a major challenge to the financial industry. The
O
pace of innovation of new technology, financial products and services has not abated.
Technological advances may change traditional methods of offering financial services at
the wholesale, and perhaps eventually, at the retail level. Job opportunities for finance
students in markets and institutions are likely to continue to improve over the next ten to
C
twenty years as managing risks at intermediaries in increasingly complex and competitive
businesses will grow in importance. For career information you may wish to refer
students to https://dhigroupinc.com/home/default.aspx. The text provides an introductory
examination of the functions and characteristics of markets and risk and profitability
management at major financial institutions in order to help students understand the
workings of the financial system in today‘s global economy.
Growth began to pick up in 2016 and market optimism increased with the election
of the new president. The unemployment rate has fallen very low and while economic
growth has not progressed as rapidly as expected. Bond market issuance continued at a
strong pace, although overall credit provided by banks experienced a delayed growth.
This implies that larger firms have had little difficulty in obtaining credit, but some
smaller firms that rely more on bank lending continue to have difficulty obtaining credit.
