The Economics of Financial Markets

by Houthakker, Hendrik S.; Williamson, Peter J.

• ISBN13: 9780195044072
• ISBN10: 019504407X
• Format: Hardcover
• Copyright: 1996-09-12
• Publisher: Oxford University Press

Summary

This book puts economics to work on the daily problems faced by investors, traders, speculators and brokers as they wrestle with increasingly complex financial markets. Drawing on data direct from the financial behavior of households, corporations, and governments, through to the prices of individual securities, the authors show how accessible but rigorous economics can help the players make sense of the hour-by-hour reality of the way financial markets move. Many of the twists and turns that might seem random at first sight are, they contend, rational and often predictable. But inefficiencies do exist, and the authors also demonstrate how these can become unique profit opportunities. By bringing together information on the daily workings of financial markets with the concepts and tools of economics, Houthakker and Williamson have provided a valuable resource for practitioners and students alike.

Author Biography

Peter J. Williamson is Professor of International Management at INSEAD (The European Institute of Business Administration).

Table of Contents

Introduction	p. 3
What This Book Is About	p. 3
Financial Markets and Financial Instruments Defined	p. 7
Basic Concepts of Accounting	p. 9
The Balance Sheet	p. 10
The Cash Flow Statement	p. 12
The Income Statement	p. 14
Sources of Information	p. 15
The Place of Financial Markets in the Economy	p. 16
Real Assets and Financial Claims	p. 16
Balance Sheets for the U.S. Economy	p. 19
The International Investment Position of the United States	p. 21
The Distribution of Financial Assets	p. 22
A Framework for Macroeconomic Analysis of Flows	p. 23
The National Accounts	p. 24
The Flow of Funds Accounts	p. 28
The Relation between Stocks and Flows	p. 30
International Transactions	p. 31
Exchange Rates	p. 32
The Rate of Interest	p. 35
The Rate of Interest in a Barter Economy	p. 35
Government Borrowing	p. 36
Introducing Money: Nominal and Real Interest Rates	p. 37
Monetary and Fiscal Policy	p. 40
The Supply of Money	p. 40
The Demand for Money	p. 43
The Objectives of Monetary Policy	p. 45
Fiscal Policy and the Government Budget	p. 46
The Supply of Securities	p. 48
General Characteristics of Securities	p. 49
The Supply of Government Securities	p. 49
Federal Government Obligations	p. 50
Municipal Bonds	p. 52
Bonds of Foreign Governments and International Organizations	p. 53
Index-Linked Bonds	p. 53
Corporate Financial Policy	p. 54
Empirical Evidence	p. 59
The Supply of Corporate Securities	p. 61
Corporate Equities	p. 62
Corporate Takeovers	p. 67
Corporate Bonds	p. 67
Junk Bonds	p. 68
Convertible Securities	p. 69
Partnership Units and Business Taxation	p. 70
Mutual Fund Shares	p. 71
Money Market Funds	p. 74
Mortgages and Mortgage-Backed Securities	p. 74
Claims on Financial Institutions	p. 75
The Demand for Securities	p. 78
The Time Dimension	p. 79
A Case in Microeconomics: Saving for Retirement	p. 79
Present Value and Duration	p. 81
The Calculation of Yields on Zero-Coupon Bonds	p. 87
The Term Structure of Interest Rates	p. 88
The Risk Dimension	p. 90
The Measurement of Risk	p. 90
Bivariate Distributions	p. 93
Expected Utility	p. 95
Estimating the Mean and Variance of Returns	p. 103
Conditional Probabilities and Expected Values	p. 104
The Portfolio Complication	p. 105
Securities Markets and Their Efficiency	p. 110
Central Trading Places	p. 111
Stock Exchanges	p. 111
Types of Orders and Their Execution	p. 116
Specialists and Market Clearing	p. 118
Financial Markets without Central Trading Places	p. 122
The Over-the-Counter Stock Market	p. 123
Stock Exchanges in Other Countries	p. 125
The International Stock Exchange in London	p. 126
The Tokyo Stock Exchange	p. 129
Operational Efficiency and the Efficient Market Hypothesis	p. 130
The Weak Form of the EMH, and Technical Analysis	p. 132
Do Equity Prices Follow a Random Walk?	p. 135
The Semistrong Form of the EMH, and Security Analysis	p. 137
How Rapidly Do Prices Adjust to News?	p. 138
The Strong Form of the EMH	p. 139
Conclusions on Informational Efficiency	p. 140
The Determination of Equity Prices	p. 141
Shares as Claims to Future Dividends	p. 142
Steady Growth in the Dividend	p. 142
Aggregate Dividends, Earnings, and Inflation	p. 145
Shares as Claims to Corporate Net Worth	p. 146
The Capital Asset Pricing Model	p. 150
The Simplest Form of CAPM	p. 151
Extending the CAPM	p. 156
Estimating Betas	p. 158
Implications for Portfolio Management	p. 159
The Validity of CAPM	p. 162
Arbitrage Pricing Theory: An Alternative Approach	p. 162
Appendix: Stock Indexes	p. 164
The Three Main Indexes	p. 164
Some Other Stock Indexes	p. 167
Security Analysis	p. 168
Security Analysis and Market Efficiency	p. 168
A Modern View of Security Analysis	p. 169
Macroeconomic Developments and Changes in Regime	p. 170
Industry Growth	p. 171
International and Regional Growth	p. 175
Industry Structure	p. 177
Firm-Specific Factors	p. 180
The Role of Financial Statement Analysis	p. 182
The Adjustment Process of Financial Ratios	p. 186
Pro-Forma Income and Cash Flow	p. 188
Caterpillar Inc.: A Security Analysis and Valuation Example	p. 191
Shortcuts in Security Valuation	p. 195
Uses and Pitfalls of Price/Earnings Ratios	p. 196
Tobin's q as an Alternative Approach to Securities Valuation	p. 198
Options and Options Pricing	p. 201
The Basics of Stock Options	p. 202
Institutional Aspects: Exchange-Traded Stock Options	p. 202
The Payoff from Buying and Selling Options	p. 205
Combinations of Options	p. 207
Combining Options with Stocks	p. 209
The Put-Call Parity Theorem	p. 211
The Valuation of Stock Options	p. 213
The Expected Payoff of a European Call	p. 215
Application of the Capital Assets Pricing Model to Options	p. 216
The Black-Scholes Formula for a European Call	p. 217
Alternative Derivations of the Black-Scholes Formula	p. 220
Other Option Models	p. 222
Some Extensions of the European Call Formula	p. 223
The Empirical Relevance of the Black-Scholes Formula	p. 226
Options and Portfolio Management	p. 226
Convertible Bonds and Stocks as Options	p. 227
Other Types of Options	p. 229
Futures Contracts and Futures Markets	p. 230
Forward Contracts	p. 231
The Origins of Futures Trading	p. 232
Basic Elements of Futures Contracts	p. 234
Delivery and Cash Settlement	p. 235
Futures and Options	p. 238
The Organization of Futures Markets	p. 240
Categories of Traders	p. 242
Types of Commodities and Financial Instruments Traded	p. 244
Volume and Open Interest	p. 246
Appendix: The Euromarkets and the Swap Market	p. 251
Innovations in Euromarket Instruments	p. 252
The Swap Market	p. 253
Futures Prices	p. 255
Profits and Losses on Various Transactions	p. 256
Implied Limits on Simultaneous Price Differences	p. 257
Relations among Spot and Futures Prices	p. 258
Financial Futures	p. 258
Nonseasonal Commodities	p. 263
Seasonal Commodities	p. 265
Hedgers, Speculators, and Market Equilibrium	p. 268
A Portfolio Analysis of Hedging	p. 269
Hedging Effectiveness	p. 271
Market Equilibrium	p. 272
The Role of Expectations	p. 273
Futures Prices as Predictors of Spot Prices	p. 274
Expectations versus Spot-Market Constraints	p. 274
Samuelson's Conjecture on Increasing Volatility	p. 276
Futures and Portfolio Management	p. 278
Program Trading	p. 278
Portfolio Insurance: A Post-mortem	p. 279
Futures Contracts as an Investment	p. 280
Regulation of Financial Markets	p. 283
The Ethics of Finance and the Economic Function of Financial Markets	p. 283
The Purposes of Regulation	p. 285
Maintaining Competition	p. 285
Preventing Fraud and Providing Information	p. 286
Levels of Regulation	p. 287
Federal Regulation of Trading in Corporate Securities	p. 288
Reporting of Financial Results and Other Developments	p. 288
New Issues	p. 289
Insider Trading	p. 290
Federal Regulation of Futures Markets	p. 290
A Case Study: The Silver Manipulation of 1979-1980	p. 292
The Silver Market	p. 292
The Manipulation	p. 293
The End of the Manipulation	p. 295
The Other Side of the Story	p. 296
The Aftermath	p. 297
Regulatory Aspects	p. 297
Regulation in the United Kingdom	p. 299
Notes	p. 303
Bibliography	p. 335
Author Index	p. 349
Subject Index	p. 351
Table of Contents provided by Syndetics. All Rights Reserved.