Financial Institutions Management+Standard and Poor's+Ethics in Finance Powerweb

by Saunders, Anthony; Cornett, Marcia Millon

• ISBN13: 9780073046679
• ISBN10: 0073046671
• Edition: 5th
• Format: Hardcover
• Copyright: 2005-01-05
• Publisher: McGraw-Hill/Irwin

Summary

Saunders and Cornett's Financial Institutions Management: A Risk Management Approach 5/e focuses on managing return and risk in modern financial institutions. The central theme is that the risks faced by financial institutions managers and the methods and markets through which these risks are managed are becoming increasingly similar whether an institution is chartered as a commercial bank, a savings bank, an investment bank, or an insurance company. Although the traditional nature of each sector's product activity is analyzed, a greater emphasis is placed on new areas of activities such as asset securitization, off-balance-sheet banking, and international banking.

Table of Contents

PART ONE INTRODUCTION	1	(178)
Why Are Financial Intermediaries Special?	2	(23)
Introduction	2	(1)
Financial Intermediaries' Specialness	3	(5)
Information Costs	6	(1)
Liquidity and Price Risk	7	(1)
Other Special Services	8	(1)
Other Aspects of Specialness	8	(2)
The Transmission of Monetary Policy	9	(1)
Credit Allocation	9	(1)
Intergenerational Wealth Transfers or Time Intermediation	9	(1)
Payment Services	10	(1)
Denomination Intermediation	10	(1)
Specialness and Regulation	10	(5)
Safety and Soundness Regulation	11	(1)
Monetary Policy Regulation	12	(1)
Credit Allocation Regulation	13	(1)
Consumer Protection Regulation	13	(1)
Investor Protection Regulation	14	(1)
Entry Regulation	14	(1)
The Changing Dynamics of Specialness	15	(6)
Trends in the United States	15	(3)
Future Trends	18	(1)
Global Issues	19	(2)
Summary	21	(4)
The Financial Services Industry: Depository Institutions	25	(39)
Introduction	25	(2)
Commercial Banks	27	(17)
Size, Structure, and Composition of the Industry	27	(4)
Balance Sheet and Recent Trends	31	(5)
Other Fee-Generating Activities	36	(1)
Regulation	36	(5)
Industry Performance	41	(3)
Savings Institutions	44	(7)
Savings Associations (SAs)	45	(4)
Savings Banks	49	(1)
Recent Performance of Savings Associations and Savings Banks	50	(1)
Credit Unions	51	(5)
Size, Structure, and Composition of the Industry and Recent Trends	52	(1)
Balance Sheets	53	(2)
Regulation	55	(1)
Industry Performance	55	(1)
Global Issues: Japan, China, and Germany	56	(1)
Summary	57	(4)
Appendix 2A Financial Statement Analysis Using a Return on Equity (ROE) Framework	61	(2)
Appendix 2B Depository Institutions and Their Regulators (www.mhhe.com/saunders5e)	63	(1)
Appendix 2C Technology in Commercial Banking (www.mhhe.com/saunders5e)	63	(1)
The Financial Services Industry: Insurance Companies	64	(28)
Introduction	64	(1)
Life Insurance Companies	64	(9)
Size, Structure, and Composition of the Industry	64	(5)
Balance Sheet and Recent Trends	69	(1)
Regulation	70	(3)
Property--Casualty Insurance	73	(12)
Size, Structure, and Composition of the Industry	73	(3)
Balance Sheet and Recent Trends	76	(8)
Regulation	84	(1)
Global Issues	85	(1)
Summary	85	(7)
The Financial Services Industry: Securities Firms and Investment Banks	92	(22)
Introduction	92	(2)
Size, Structure, and Composition of the Industry	94	(7)
Balance Sheet and Recent Trends	101	(4)
Recent Trends	101	(3)
Balance Sheet	104	(1)
Regulation	105	(4)
Global Issues	109	(1)
Summary	110	(4)
The Financial Services Industry: Mutual Funds	114	(30)
Introduction	114	(1)
Size, Structure, and Composition of the Industry	115	(15)
Historical Trends	115	(2)
Different Types of Mutual Funds	117	(4)
Mutual Fund Objectives	121	(1)
Investor Returns from Mutual Fund Ownership	122	(3)
Mutual Fund Costs	125	(3)
Mutual Fund Share Quotes	128	(2)
Balance Sheet and Recent Trends	130	(2)
Money Market Funds	130	(1)
Long-Term Funds	131	(1)
Regulation	132	(4)
Global Issues	136	(2)
Summary	138	(3)
Appendix 5A Hedge Funds	141	(3)
The Financial Services Industry: Finance Companies	144	(13)
Introduction	144	(1)
Size, Structure, and Composition of the Industry	144	(3)
Balance Sheet and Recent Trends	147	(6)
Assets	147	(4)
Liabilities and Equity	151	(1)
Industry Performance	152	(1)
Regulation	153	(1)
Global Issues	154	(1)
Summary	155	(2)
Risks of Financial Intermediation	157	(22)
Introduction	157	(1)
Interest Rate Risk	157	(4)
Market Risk	161	(1)
Credit Risk	162	(2)
Off-Balance-Sheet Risk	164	(1)
Technology and Operational Risks	165	(2)
Foreign Exchange Risk	167	(2)
Country or Sovereign Risk	169	(1)
Liquidity Risk	170	(1)
Insolvency Risk	171	(1)
Other Risks and the Interaction of Risks	172	(1)
Summary	173	(6)
PART TWO MEASURING RISK	179	(316)
Interest Rate Risk I	180	(36)
Introduction	180	(1)
The Central Bank and Interest Rate Risk	181	(2)
The Repricing Model	183	(8)
Rate-Sensitive Assets	185	(1)
Rate-Sensitive Liabilities	186	(2)
Equal Changes in Rates on RSAs and RSLs	188	(1)
Unequal Changes in Rates on RSAs and RSLs	189	(2)
Weaknesses of the Repricing Model	191	(3)
Market Value Effects	191	(1)
Overaggregation	191	(1)
The Problem of Runoffs	192	(1)
Cash Flows from Off-Balance-Sheet Activities	193	(1)
The Maturity Model	194	(7)
The Maturity Model with a Portfolio of Assets and Liabilities	197	(4)
Weaknesses of the Maturity Model	201	(3)
Summary	204	(7)
Appendix 8A Term Structure of Interest Rates	211	(4)
Appendix 8B The Basics of Bond Valuation (www.mhhe.com/saunders5e)	215	(1)
Interest Rate Risk II	216	(42)
Introduction	216	(1)
Duration	216	(3)
A General Formula for Duration	219	(4)
The Duration of Interest-Bearing Bonds	220	(1)
The Duration of a Zero-Coupon Bond	221	(1)
The Duration of a Consol Bond (Perpetuities)	222	(1)
Features of Duration	223	(1)
Duration and Maturity	223	(1)
Duration and Yield	223	(1)
Duration and Coupon Interest	224	(1)
The Economic Meaning of Duration	224	(4)
Semiannual Coupon	227	(1)
Duration and Immunization	228	(8)
Duration and Immunizing Future Payments	228	(3)
Immunizing the Whole Balance Sheet of an FI	231	(5)
Immunization and Regulatory Considerations	236	(1)
Difficulties in Applying the Duration Model	237	(4)
Duration Matching Can Be Costly	237	(1)
Immunization Is a Dynamic Problem	238	(1)
Large Interest Rate Changes and Convexity	239	(2)
Summary	241	(7)
Appendix 9A Incorporating Convexity into the Duration Model	248	(10)
Market Risk	258	(29)
Introduction	258	(2)
Market Risk Measurement	260	(1)
Calculating Market Risk Exposure	261	(1)
The RiskMetrics Model	261	(9)
The Market Risk of Fixed-Income Securities	263	(2)
Foreign Exchange	265	(1)
Equities	266	(1)
Portfolio Aggregation	267	(3)
Historic (Back Simulation) Approach	270	(5)
The Historic (Back Simulation) Model versus RiskMetrics	273	(1)
The Monte Carlo Simulation Approach	274	(1)
Regulatory Models: The BIS Standardized Framework	275	(5)
Fixed Income	275	(4)
Foreign Exchange	279	(1)
Equities	279	(1)
The BIS Regulations and Large Bank Internal Models	280	(2)
Summary	282	(5)
Credit Risk: Individual Loan Risk	287	(55)
Introduction	287	(1)
Credit Quality Problems	288	(2)
Types of Loans	290	(7)
Commercial and Industrial Loans	290	(3)
Real Estate Loans	293	(1)
Individual (Consumer) Loans	294	(3)
Other Loans	297	(1)
Calculating the Return on a Loan	297	(4)
The Contractually Promised Return on a Loan	297	(3)
The Expected Return on a Loan	300	(1)
Retail versus Wholesale Credit Decisions	301	(2)
Retail	301	(1)
Wholesale	301	(2)
Measurement of Credit Risk	303	(1)
Default Risk Models	304	(7)
Qualitative Models	304	(3)
Credit Scoring Models	307	(4)
Newer Models of Credit Risk Measurement and Pricing	311	(16)
Term Structure Derivation of Credit Risk	311	(7)
Mortality Rate Derivation of Credit Risk	318	(1)
RAROC Models	319	(3)
Option Models of Default Risk	322	(5)
Summary	327	(29)
Appendix 11A CreditMetrics	356
Appendix 11B Credit Risk+	339	(3)
Appendix 11C Credit Analysis (www.mhhe.com/saunders5e)
Credit Risk: Loan Portfolio and Concentration Risk	342	(15)
Introduction	342	(1)
Simple Models of Loan Concentration Risk	342	(2)
Loan Portfolio Diversification and Modern Portfolio Theory (MPT)	344	(10)
KMV Portfolio Manager Model	347	(2)
Partial Applications of Portfolio Theory	349	(3)
Loan Loss Ratio--Based Models	352	(1)
Regulatory Models	353	(1)
Summary	354	(3)
Off-Balance-Sheet Risk	357	(26)
Introduction	357	(2)
Off-Balance-Sheet Activities and FI Solvency	359	(3)
Returns and Risks of Off-Balance-Sheet Activities	362	(12)
Loan Commitments	364	(4)
Commercial Letters of Credit and Standby Letters of Credit	368	(2)
Derivative Contracts: Futures, Forwards, Swaps, and Options	370	(2)
Forward Purchases and Sales of When Issued Securities	372	(1)
Loans Sold	373	(1)
Non-schedule L Off-Balance-Sheet Risks	374	(2)
Settlement Risk	374	(1)
Affiliate Risk	375	(1)
The Role of OBS Activities in Reducing Risk	376	(1)
Summary	377	(6)
Appendix 13A A Letter of Credit Transaction (www.mhhe.com/saunders5e)
Technology and Other Operational Risks	383	(34)
Introduction	383	(1)
What are the Sources of Operational Risk?	384	(1)
Technological Innovation and Profitability	384	(3)
The Impact of Technology on Wholesale and Retail Financial Service Production	387	(3)
Wholesale Financial Services	387	(1)
Retail Financial Services	388	(2)
The Effect of Technology on Revenues and Costs	390	(7)
Technology and Revenues	391	(1)
Technology and Costs	392	(5)
Testing for Economies of Scale and Economies of Scope	397	(1)
The Production Approach	397	(1)
The Intermediation Approach	397	(1)
Empirical Findings on Cost Economies of Scale and Scope and Implications for Technology Expenditures	397	(2)
Economies of Scale and Scope and X-Inefficiencies	398	(1)
Technology and the Evolution of the Payments System	399	(9)
Risks That Arise in an Electronic Transfer Payment System	402	(6)
Other Operational Risks	408	(3)
Regulatory Issues and Technology and Operational Risks	411	(2)
Summary	413	(4)
Foreign Exchange Risk	417	(20)
Introduction	417	(1)
Sources of Foreign Exchange Risk Exposure	417	(4)
Foreign Exchange Rate Volatility and FX Exposure	420	(1)
Foreign Currency Trading	421	(2)
FX Trading Activities	422	(1)
The Profitability of Foreign Currency Trading	422	(1)
Foreign Asset and Liability Positions	423	(9)
The Return and Risk of Foreign Investments	424	(1)
Risk and Hedging	425	(5)
Interest Rate Parity Theorem	430	(1)
Multicurrency Foreign Asset--Liability Positions	431	(1)
Summary	432	(5)
Sovereign Risk	437	(32)
Introduction	437	(3)
Credit Risk versus Sovereign Risk	440	(1)
Debt Repudiation versus Debt Rescheduling	441	(1)
Country Risk Evaluation	442	(17)
Outside Evaluation Models	443	(1)
Internal Evaluation Models	443	(3)
The Debt Service Ratio (DSR)	446	(1)
The Import Ratio (IR)	446	(1)
Investment Ratio (INVR)	447	(1)
Variance of Export Revenue (Varex)	448	(1)
Domestic Money Supply Growth (MG)	448	(6)
Using Market Data to Measure Risk: The Secondary Market for LDC Debt	454	(5)
Summary	459	(6)
Appendix 16A Mechanisms for Dealing with Sovereign Risk Exposure	465	(4)
Liquidity Risk	469	(26)
Introduction	469	(1)
Causes of Liquidity Risk	469	(1)
Liquidity Risk at Depository Institutions	470	(15)
Liability-Side Liquidity Risk	470	(4)
Asset-Side Liquidity Risk	474	(1)
Measuring a Bank's Liquidity Exposure	475	(6)
Liquidity Risk, Unexpected Deposit Drains, and Bank Runs	481	(3)
Bank Runs, the Discount Window, and Deposit Insurance	484	(1)
Liquidity Risk and Life Insurance Companies	485	(1)
Liquidity Risk and Property--Casualty Insurers	485	(1)
Mutual Funds	486	(2)
Summary	488	(7)
Appendix 17A Sources and Uses of Funds Statements, Bank of America (www.mhhe.com/saunders5e)
PART THREE MANAGING RISK	495	(274)
Liability and Liquidity Management	496	(30)
Introduction	496	(1)
Liquid Asset Management	496	(2)
Monetary Policy Implementation Reasons	497	(1)
Taxation Reasons	498	(1)
The Composition of the Liquid Asset Portfolio	498	(1)
Return-Risk Trade-Off for Liquid Assets	499	(7)
The Liquid Asset Reserve Management Problem for U.S. Depository Institutions	499	(4)
Undershooting/Overshooting of the Reserve Target	503	(3)
Liability Management	506	(1)
Funding Risk and Cost	507	(1)
Choice of Liability Structure	507	(8)
Demand Deposits	508	(1)
Interest-Bearing Checking (NOW) Accounts	509	(1)
Passbook Savings	510	(1)
Money Market Deposit Accounts (MMDAs)	510	(1)
Retail Time Deposits and CDs	511	(1)
Wholesale CDs	512	(1)
Federal Funds	513	(1)
Repurchase Agreements (RPs)	513	(1)
Other Borrowings	514	(1)
Liquidity and Liability Structures for U.S. Depository Institutions	515	(2)
Liability and Liquidity Risk Management in Insurance Companies	517	(1)
Liability and Liquidity Risk Management in Other Fls	518	(1)
Summary	518	(8)
Appendix 18A Federal Reserve Requirement Accounting (www.mhhe.com/saunders5e)
Appendix 18B Bankers Acceptances and Commercial Paper as a Source of Financing (www.mhhe.com/saunders5e)
Deposit Insurance and Other Liability Guarantees	526	(41)
Introduction	526	(1)
Bank and Thrift Guaranty Funds	527	(3)
The Causes of the Depository Fund Insolvencies	530	(1)
The Financial Environment	530	(1)
Moral Hazard	530	(1)
Panic Prevention versus Moral Hazard	531	(2)
Controlling Depository Institution Risk Taking	533	(20)
Stockholder Discipline	533	(9)
Depositor Discipline	542	(10)
Regulatory Discipline	552	(1)
Non-U.S. Deposit Insurance Systems	553	(1)
The Discount Window	554	(2)
Deposit Insurance versus the Discount Window	554	(1)
The Discount Window	554	(2)
Other Guaranty Programs	556	(4)
National Credit Union Administration	557	(1)
Property--Casualty and Life Insurance Companies	557	(1)
The Securities Investor Protection Corporation	558	(1)
The Pension Benefit Guaranty Corporation	559	(1)
Summary	560	(7)
Appendix 19A FDIC Press Releases of Bank Failures (www.mhhe.com/saunders5e)
Appendix 19B Deposit Insurance Schemes for Commercial Banks in Various Countries (www.mhhe.com/saunders5e)
Capital Adequacy	567	(48)
Introduction	567	(1)
Capital and Insolvency Risk	568	(7)
Capital	568	(1)
The Market Value of Capital	568	(3)
The Book Value of Capital	571	(2)
The Discrepancy between the Market and Book Values of Equity	573	(1)
Arguments against Market Value Accounting	574	(1)
Capital Adequacy in the Commercial Banking and Thrift Industry	575	(26)
Actual Capital Rules	575	(1)
The Capital-Assets Ratio (or Leverage Ratio)	576	(1)
Risk--Based Capital Ratios	577	(5)
Calculating Risk-Based Capital Ratios	582	(19)
Capital Requirements for Other Fls	601	(3)
Securities Firms	601	(1)
Life Insurance	601	(2)
Property-Casualty Insurance	603	(1)
Summary	604	(9)
Appendix 20A Internal Ratings--Based Approach to Measuring Credit Risk--Adjusted Assets	613	(2)
Product Diversification	615	(29)
Introduction	615	(1)
Risks of Product Segmentation	615	(2)
Segmentation in the U.S. Financial Services Industry	617	(7)
Commercial and Investment Banking Activities	617	(3)
Banking and Insurance	620	(2)
Commercial Banking and Commerce	622	(1)
Nonbank Financial Service Firms and Commerce	623	(1)
Activity Restrictions in the United States versus Other Countries	624	(2)
Issues Involved in the Diversification of Product Offerings	626	(13)
Safety and Soundness Concerns	627	(5)
Economies of Scale and Scope	632	(1)
Conflicts of Interest	633	(2)
Deposit Insurance	635	(1)
Regulatory Oversight	636	(1)
Competition	636	(3)
Summary	639	(5)
Geographic Diversification: Domestic	644	(26)
Introduction	644	(1)
Domestic Expansions	644	(1)
Regulatory Factors Impacting Geographic Expansion	645	(7)
Insurance Companies	645	(1)
Thrifts	645	(1)
Commercial Banks	646	(6)
Cost and Revenue Synergies Impacting Geographic Expansion by Merger and Acquisition	652	(8)
Cost Synergies	653	(3)
Revenue Synergies	656	(1)
Merger Guidelines for Acceptability	657	(3)
Other Market- and Firm-Specific Factors Impacting Geographic Expansion Decisions	660	(2)
The Success of Geographic Expansions	662	(4)
Investor Reaction	662	(1)
Postmerger Performance	663	(3)
Summary	666	(4)
Geographic Diversification: International	670	(16)
Introduction	670	(1)
Global and International Expansions	670	(10)
U.S. Banks Abroad	671	(4)
Foreign Banks in the United States	675	(5)
Advantages and Disadvantages of International Expansion	680	(3)
Advantages	680	(2)
Disadvantages	682	(1)
Summary	683	(3)
Futures and Forwards	686	(36)
Introduction	686	(2)
Forward and Futures Contracts	688	(2)
Spot Contracts	688	(2)
Forward Contracts	690	(1)
Futures Contracts	690	(1)
Forward Contracts and Hedging Interest Rate Risk	690	(2)
Hedging Interest Rate Risk with Futures Contracts	692	(10)
Microhedging	692	(1)
Macrohedging	692	(1)
Routine Hedging versus Selective Hedging	693	(1)
Macrohedging with Futures	694	(7)
The Problem of Basis Risk	701	(1)
Hedging Foreign Exchange Risk	702	(8)
Forwards	703	(1)
Futures	703	(4)
Estimating the Hedge Ratio	707	(3)
Hedging Credit Risk with Futures and Forwards	710	(3)
Credit Forward Contracts and Credit Risk Hedging	710	(2)
Futures Contracts and Catastrophe Risk	712	(1)
Futures and Forward Policies of Regulators	712	(1)
Summary	713	(9)
Appendix 24A Microhedging with Futures (www.mhhe.com/saunders5e)
Options, Caps, Floors, and Collars	722	(39)
Introduction	722	(1)
Basic Features of Options	722	(4)
Buying a Call Option on a Bond	722	(2)
Writing a Call Option on a Bond	724	(1)
Buying a Put Option on a Bond	724	(1)
Writing a Put Option on a Bond	725	(1)
Writing versus Buying Options	726	(3)
Economic Reasons for Not Writing Options	726	(2)
Regulatory Reasons	728	(1)
Futures versus Options Hedging	728	(1)
The Mechanics of Hedging a Bond or Bond Portfolio	729	(4)
Hedging with Bond Options Using the Binomial Model	730	(3)
Actual Bond Options	733	(2)
Using Options to Hedge Interest Rate Risk on the Balance Sheet	735	(4)
Using Options to Hedge Foreign Exchange Risk	739	(2)
Hedging Credit Risk with Options	741	(1)
Hedging Catastrophe Risk with Call Spread Options	742	(1)
Caps, Floors, and Collars	743	(8)
Caps	743	(4)
Floors	747	(1)
Collars	747	(4)
Caps, Floors, Collars, and Credit Risk	751	(1)
Summary	751	(10)
Appendix 25A Black-Scholes Option Pricing Model (www.mhhe.com/saunders5e)
Appendix 25B Microhedging with Options (www.mhhe.com/ saunders5e)
Swaps	761	(28)
Introduction	761	(1)
Interest Rate Swaps	761	(8)
Realized Cash Flows on an Interest Rate Swap	765	(2)
Macrohedging with Swaps	767	(2)
Currency Swaps	769	(3)
Fixed-Fixed Currency Swaps	769	(2)
Fixed-Floating Currency Swaps	771	(1)
Credit Swaps	772	(3)
Total Return Swaps	773	(1)
Pure Credit Swaps	774	(1)
Swaps and Credit Risk Concerns	775	(2)
Netting and Swaps	776	(1)
Payment Flows Are Interest and Not Principal	776	(1)
Standby Letters of Credit	776	(1)
Summary	777	(6)
Appendix 26A Pricing an Interest Rate Swap	783	(6)
Loan Sales and Other Credit Risk Management Techniques	789	(18)
Introduction	789	(1)
Loan Sales	790	(2)
The Bank Loan Sales Market	792	(8)
Definition of a Loan Sale	792	(1)
Types of Loan Sales	793	(1)
Types of Loan Sales Contracts	794	(1)
The Buyers and the Sellers	795	(5)
Why Banks and Other Fls Sell Loans	800	(1)
Reserve Requirements	800	(1)
Fee Income	801	(1)
Capital Costs	801	(1)
Liquidity Risk	801	(1)
Factors Deterring Loan Sales Growth in the Future	801	(2)
Access to the Commercial Paper Market	802	(1)
Customer Relationship Effects	802	(1)
Legal Concerns	802	(1)
Factors Encouraging Loan Sales Growth in the Future	803	(1)
BIS Capital Requirements	803	(1)
Market Value Accounting	803	(1)
Asset Brokerage and Loan Trading	803	(1)
Government Loan Sales	803	(1)
Credit Ratings	803	(1)
Purchase and Sale of Foreign Bank Loans	804	(1)
Summary	804	(3)
Securitization	807
Introduction	807	(1)
The Pass-Through Security	807	(20)
GNMA	807	(1)
FNMA	808	(1)
FHLMC	808	(2)
The Incentives and Mechanics of Pass-Through Security Creation	810	(4)
Prepayment Risk on Pass-Through Securities	814	(5)
Prepayment Models	819	(8)
The Collateralized Mortgage Obligation (CMO)	827	(5)
Creation of CMOs	827	(2)
Class A, B, and C Bond Buyers	829	(1)
Other CMO Classes	830	(2)
The Mortgage-Backed Bond (MBB)	832	(2)
Innovations in Securitization	834	(3)
Mortgage Pass-Through Strips	834	(3)
Securitization of Other Assets	837	(1)
Can All Assets Be Securitized?	837	(2)
Summary	839
Appendix 28A Fannie Mae and Freddie Mac Balance Sheets (www.mhhe.com/saunders5e)
Index	769