CHAPTER 1: INTRODUCTION
CHAPTER 2.1: DETERMINANTS OF INTEREST RATES
CHAPTER 2.2: MONEY MARKET
CHAPTER 3: BOND MARKETS
CHAPTER 4: STOCK MARKETS
CHAPTER 5: MORTGAGE MARKETS
CHAPTER 6: FOREIGN EXCHANGE MARKETS
CHAPTER 7: DERIVATIVE SECURITIES MARKETS
CHAPTER 1: INTRODUCTION
TABLE 1–1 Types of Financial Markets
Primary markets—markets in which corporations raise funds through new issues of securities.
Secondary markets—markets that trade financial instruments once they are issued.
Money markets—markets that trade debt securities or instruments with maturities of less than one year.
Capital markets—markets that trade debt and equity instruments with maturities of more than one year.
Foreign exchange markets—markets in which cash flows from the sale of products or assets
denominated in a foreign currency are transacted.
Derivative markets—markets in which derivative securities trade.
TABLE 1–3 Money and Capital Market Instruments
MONEY MARKET INSTRUMENTS
Treasury bills—short-term obligations issued by the U.S. government.
Federal funds—short-term funds transferred between financial institutions usually for no more than
one day.
Repurchase agreements—agreements involving the sale of securities by one party to another with a
promise by the seller to repurchase the same securities from the buyer at a specified date and price.
Commercial paper—short-term unsecured promissory notes issued by a company to raise short-term
cash.
Negotiable certificates of deposit—bank-issued time deposits that specify an interest rate and maturity
date and are negotiable (i.e., can be sold by the holder to another party).
Banker’s acceptances—time drafts payable to a seller of goods, with payment guaranteed by a bank.
CAPITAL MARKET INSTRUMENTS
Corporate stock—the fundamental ownership claim in a public corporation.
Mortgages—loans to individuals or businesses to purchase a home, land, or other real property.
Corporate bonds—long-term bonds issued by corporations.
Treasury bonds—long-term bonds issued by the U.S. government.
State and local government bonds—long-term bonds issued by state and local governments.
U.S. government agency bonds—long-term bonds collateralized by a pool of assets and issued by
agencies of the U.S. government.
Bank and consumer loans—loans to commercial banks and individuals.
TABLE 1–5 Types of Financial Institutions
Commercial banks—depository institutions whose major assets are loans and whose major liabilities
are deposits. Commercial banks’ loans are broader in range, including consumer, commercial, and real
estate loans, than are those of other depository institutions. Commercial banks’ liabilities include more
nondeposit sources of funds, such as subordinate notes and debentures, than do those of other depository
institutions.
Thrifts—depository institutions in the form of savings associations, savings banks, and credit unions.
1
Thrifts generally perform services similar to commercial banks, but they tend to concentrate their loans
in one segment, such as real estate loans or consumer loans.
Insurance companies—financial institutions that protect individuals and corporations (policyholders)
from adverse events. Life insurance companies provide protection in the event of untimely death,
illness, and retirement. Property casualty insurance protects against personal injury and liability due to
accidents, theft, fire, and so on.
Securities firms and investment banks—financial institutions that help firms issue securities and
engage in related activities such as securities brokerage and securities trading.
Finance companies—financial intermediaries that make loans to both individuals and businesses.
Unlike depository institutions, finance companies do not accept deposits but instead rely on short- and
long-term debt for funding.
Investment funds—financial institutions that pool financial resources of individuals and companies and
invest those resources in diversified portfolios of assets.
Pension funds—financial institutions that offer savings plans through which fund participants
accumulate savings during their working years before withdrawing them during their retirement years.
Funds originally invested in and accumulated in pension funds are exempt from current taxation.
Fintechs—institutions that use technology to deliver financial solutions in a manner that competes with
traditional financial methods.
TABLE 1–6 Services Performed by Financial Institutions
Services Benefiting Suppliers of Funds:
Monitoring costs—aggregation of funds in an FI provides greater incentive to collect a firm’s
information and monitor actions. The relatively large size of the FI allows this collection of information
to be accomplished at a lower average cost (economies of scale).
Liquidity and price risk—FIs provide financial claims to household savers with superior liquidity
attributes and with lower price risk.
Transaction cost services—similar to economies of scale in information production costs, an FI’s size
can result in economies of scale in transaction costs.
Maturity intermediation—FIs can better bear the risk of mismatching the maturities of their assets and
liabilities.
Denomination intermediation—FIs such as mutual funds allow small investors to overcome
constraints to buying assets imposed by large minimum denomination size.
Services Benefiting the Overall Economy:
Money supply transmission—depository institutions are the conduit through which monetary policy
actions impact the rest of the financial system and the economy in general.
Credit allocation—FIs are often viewed as the major, and sometimes only, source of financing for a
particular sector of the economy, such as farming and residential real estate.
Intergenerational wealth transfers—FIs, especially life insurance companies and pension funds,
provide savers with the ability to transfer wealth from one generation to the next.
Payment services—the efficiency with which depository institutions provide payment services directly
benefits the economy.
CHAPTER 2: DETERMINANTS OF INTEREST RATES
TABLE 2–2 Factors That Affect the Supply of and Demand for Loanable Funds for a
Financial Security
Panel A: The supply of funds
Factor Impact on Supply of Funds Impact on Equilibrium
Interest Rate*
Interest rate Movement along the supply Direct
curve
Total wealth Shift supply curve Inverse
Risk of financial security Shift supply curve Direct
Near-term spending needs Shift supply curve Direct
Monetary expansion Shift supply curve Inverse
Economic conditions Shift supply curve Inverse
2
Panel B: The demand for funds
Factor Impact on Demand for Impact on Equilibrium
Funds Interest Rate
Interest rate Movement along the demand Direct
curve
Utility derived from asset purchased Shift demand curve Direct
with borrowed funds
Restrictiveness of nonprice condition Shift demand curve Inverse
Economic conditions Shift demand curve Direct
TABLE 2–3 Factors Affecting Nominal Interest Rates
Inflation—the continual increase in the price level of a basket of goods and services.
Real risk-free rate—nominal risk-free rate that would exist on a security if no inflation were expected.
Default risk—risk that a security issuer will default on the security by missing an interest or principal
payment.
Liquidity risk—risk that a security cannot be sold at a predictable price with low transaction costs at
short notice.
Special provisions—provisions (e.g., taxability, convertibility, and callability) that impact the security
holder beneficially or adversely and as such are reflected in the interest rates on securities that contain
such provisions.
Term to maturity—length of time a security has until maturity.
TABLE 2–4 Explanations for the Shape of the Term Structure of Interest Rates
Unbiased expectations theory—at any given point in time, the yield curve reflects the market’s current
expectations of future short-term rates. According to the unbiased expectations theory, the return for
holding a four-year bond to maturity should equal the expected return for investing in four successive
one-year bonds (as long as the market is in equilibrium).
Liquidity premium theory—long-term rates are equal to geometric averages of current and expected
short-term rates, plus liquidity risk premiums that increase with the security’s maturity. Longer
maturities on securities mean greater market and liquidity risk. So, investors will hold long-term
maturities only when they are offered at a premium to compensate for future uncertainty in the security’s
value. The liquidity premium increases as maturity increases.
Market segmentation theory—assumes that investors do not consider securities with different
maturities as perfect substitutes. Rather, individual investors and FIs have preferred investment horizons
(habitats) dictated by the nature of the liabilities they hold. Thus, interest rates are determined by distinct
supply and demand conditions within a particular maturity segment (e.g., the short end and long end of
the bond market).
CHAPTER 2: MONEY MARKET
TABLE 5–2 Money Market Instruments
Treasury bills—short-term obligations issued by the U.S. government.
Federal funds—short-term funds transferred between financial institutions usually for no more
than one day.
Repurchase agreements—agreements involving the sale of securities by one party to another with
a promise to repurchase the securities at a specified date and price. Commercial paper—short-
term unsecured promissory notes issued by a company to raise short-term cash.
Negotiable certificates of deposit—bank-issued time deposits that specify an interest rate and
maturity date and are negotiable (saleable on a secondary market).
Banker’s acceptances—time drafts payable to a seller of goods, with payment guaranteed by a
bank
TABLE 5–6 Money Market Participants
Instrument Principal Issuer Principal Investor
3
Treasury bills U.S. Treasury Federal Reserve System
Commercial banks
Mutual funds
Brokers and dealers
Other financial institutions
Corporations
Individuals
Federal funds Commercial banks Commercial banks
Repurchase agreements Federal Reserve System Federal Reserve System
Commercial banks Commercial banks
Brokers and dealers Mutual funds
Other financial institutions Brokers and dealers
Other financial institutions
Corporations
Commercial paper Commercial banks Brokers and dealers
Other financial institutions Mutual funds
Corporations Corporations
Negotiable CDs Commercial banks Other financial institutions
Individuals
Banker’s acceptances Commercial banks Brokers and dealers
Mutual funds
Corporations
CHAPTER 3: BOND MARKETS
TABLE 6–3 Auction Pattern for Treasury Notes and Bonds
Security Purchase Minimum General Auction Schedule
2-year note $100 Monthly
3-year note $100 Monthly
5-year note $100 Monthly
7-year note $100 Monthly
10-year note $100 February, May, August, November
30-year note $100 February, May, August, November
TABLE 6–8 Bond Characteristics
Bearer bonds—bonds on which coupons are attached. The bond holder presents the coupons to the
issuer for payments of interest when they come due.
Registered bonds—with a registered bond, the owner’s identification information is recorded by
the issuer and the coupon payments are mailed to the registered owner.
Term bonds—bonds in which the entire issue matures on a single date.
Serial bonds—bonds that mature on a series of dates, with a portion of the issue paid off on each.
Mortgage bonds—bonds that are issued to finance specific projects that are pledged as collateral
for the bond issue.
Equipment trust certificates—bonds collateralized with tangible non–real estate property (e.g.,
railcars and airplanes).
Debentures—bonds backed solely by the general credit of the issuing firm and unsecured by
specific assets or collateral.
Subordinated debentures—unsecured debentures that are junior in their rights to mortgage bonds
and regular debentures.
Convertible bonds—bonds that may be exchanged for another security of the issuing firm at the
discretion of the bond holder.
Stock warrants—bonds that give the bond holder an opportunity to purchase common stock at a
specified price up to a specified date.
Callable bonds—bonds that allow the issuer to force the bond holder to sell the bond back to the
4
issuer at a price above the par value (at the call price).
Sinking fund provisions—bonds that include a requirement that the issuer retire a certain amount
of the bond issue each year.
CHAPTER 7: DERIVATIVE SECURITIES MARKETS
TABLE 10–1 Spot, Forward, and Futures Contracts
Spot contract—agreement made between a buyer and a seller at time 0 for the seller to deliver the
asset immediately and the buyer to pay for the asset immediately. Forward contract—agreement
between a buyer and a seller at time 0 to exchange a nonstandardized asset for cash at some future
date. The details of the asset and the price to be paid at the forward contract expiration date are set
at time 0. The price of the forward contract is fixed over the life of the contract.
Futures contract—agreement between a buyer and a seller at time 0 to exchange a standardized
asset for cash at some future date. Each contract has a standardized expiration and transactions
occur in a centralized market. The price of the futures contract changes daily as the market value of
the asset underlying the futures fluctuates.
TABLE 10–3 Contract Terms for 10-Year Treasury Note Futures
Underlying unit—one U.S. Treasury note having a face value at maturity of $100,000.
Deliverable grades—U.S. Treasury notes with a remaining term to maturity of at least 6½ years,
but not more than 10 years, from the first day of the delivery month. The invoice price equals the
futures settlement price times a conversion factor, plus accrued interest. The conversion factor is
the price of the delivered note ($1 par value) to yield 6 percent.
Price quote—points ($1,000) and halves of 1/32 of a point. For example, 126-16 represents 126
16/32 and 126-165 represents 126 16.5/32. Par is on the basis of 100 points.
Tick size (minimum fluctuation)—one-half of one thirty-second (1/32) of one point ($15.625,
rounded up to the nearest cent per contract), except for intermonth spreads, where the minimum
price fluctuation will be one-quarter of one thirty-second of one point ($7.8125 per contract).
Contract months—the first three consecutive contracts in the March, June, September, and
December quarterly cycle.
Last trading day—seventh business day preceding the last business day of the delivery month.
Trading in expiring contracts closes at 12:01 p.m. on the last trading day.
Last delivery day—last business day of the delivery month.
Delivery method—Federal Reserve book-entry wire-transfer system.
Settlement—U.S. Treasury Futures Settlement Procedures.
Position limits—CBOT position limits.
Trading hours (all times listed are central time)—Sunday–Friday: 5:00 p.m.–4:00 p.m. CST with
a 60-minute break each day beginning at 4:00 p.m. CST.
Ticker symbol—CME ClearPort—21; Clearing—21; CME Globex—ZN
Exchange rule—these contracts are listed with, and subject to, the rules and regulations of the
CBOT.
