Finance and Financial Markets

Third Edition

by Keith Pilbeam

Sample Material for Finance and Financial Markets, 3rd edition

Download the table of contents and the first chapter of Finance and Financial Markets, 3rd edition. You can also read Keith Pilbeam's preface to the third edition below.

Table of Contents and Sample Chapter

Preface by Keith Pilbeam

The importance of financial markets, institutions and instruments to the successful operation of a modern economy has grown markedly during the last five decades.

Indeed, the world of finance has itself undergone remarkable changes during this period. Financial institutions have become less regulated and increasingly international in their outlook. Markets are less segmented, with money markets, foreign exchange, bond markets, stockmarkets and derivative markets becoming ever more inextricably linked. Moreover, domestic and foreign markets are increasingly interdependent, with movements in foreign financial markets exerting significant impacts on domestic markets. More recently, the range of international financial markets has increased, with developing countries such as China and India experiencing very high rates of economic growth and attempting to improve the functioning of their financial institutions and markets. Likewise, the Eastern-bloc countries have been keen to develop their financial services sectors. Finally, the range of financial instruments that are traded has mushroomed, with investors and borrowers being able to choose from an ever-increasing range of risk–return products. A good example of this phenomenon has been the exponential growth of trading in derivative instruments such as options, futures and swaps. Even more recent financial innovations have included collateralized debt obligations and credit default swaps, which played a crucial role in the credit crunch.

The increasing importance of finance has inevitably been reflected in the popularity of courses dealing with finance theory, financial markets and financial instruments at both the undergraduate and postgraduate level. Indeed, these days virtually all MBA programmes have finance -related core or elective courses. This third edition of Finance and Financial Markets is designed to be a comprehensive, and at the same time accessible, introduction to financial institutions, markets and instruments for undergraduate and MBA students. I hope that it builds upon the success of the first two editions. Many excellent books on finance are written to quite an advanced level and tend to adopt a relatively technical approach to the topic. The aim of this book is to provide a less technical and more practically oriented introduction to the field of finance whilst maintaining a reasonable degree of rigour. The book provides enough coverage to satisfy most introductory courses; however, it is hoped that the book will also serve as a springboard to the more advanced texts.

The opening five chapters provide an introduction to the world of finance and cover the basic theory relating to the operation of financial institutions and the domestic and off shore (Eurocurrency) money markets. Chapters 6 to 10 deal with both the theory and practice relating to capital markets. The theory covers areas such as portfolio diversification, the capital asset pricing model, the Gordon growth model and the efficient market hypothesis, while the practice looks at the domestic and international bond markets and equity markets. Chapters 11 and 12 are devoted to the foreign exchange market. Chapter 11 provides an introduction to the spot and forward markets and Chapter 12 presents an analysis of the purchasing power parity theory and more modern theories of exchange rate determination. Chapters 13 to 16 are concerned with derivative instruments. Chapter 13 looks at forwards and futures contracts, and specific examples of currency, bond and equity index contracts are included. Chapters 14 and 15 look at options. Chapter 14 examines what options are, how they can be used for speculative and hedging purposes and at various option strategies, while Chapter 15 focuses on the more complex issue of option pricing and in particular the Black–Scholes option pricing formula. Chapter 16 looks at the swap market, which since the first swaps agreements were made in the 1980s has become increasingly important to the operation of domestic and international bond markets. Chapter 17 is a brand new chapter entitled ‘Financial Innovation and the Credit Crunch’. It looks at two of the crucial financial innovations that played a significant role in the crisis, namely collateralized debt obligations (CDOs) and credit default swaps (CDSs) and argues that these financial innovations were ‘misunderstood, misrated, mis-sold and mispriced’ by financial market participants. The chapter looks at the causes of the crisis, its evolution and the policy response as well as some of the lessons that will hopefully be learnt. Finally, Chapter 18 provides an analysis of the crucial issue of regulation of the financial sector. It has been extensively rewritten to reflect issues arising from the credit crunch.
The first two editions have undergone substantial change to create this third edition, including the addition of a significant amount of new data and extensive rewriting, along with the incorporation of more worked examples. The new chapter on the credit crunch makes this one of the first texts to include an extensive and up-to-date analysis of the crisis and to give detailed coverage of financial instruments such as collateralized debt obligations and credit default swaps. Another major addition for the new edition are 26 boxed features covering a large variety of subjects related to the real world of finance. The boxes cover such diverse topics as the collapse of Lehman Brothers and American International Group, the carry trade, initial public offerings and the dot com bubble, Islamic finance, Sovereign Wealth Funds, behavioural finance, the TED spread, the VIX index, bankers’ bonuses and other areas of current interest. The aim of these boxes is to provoke class discussion and to remind students that finance is not just about equations and statistics – it includes other dimensions such as human psychology, politics and error.
A significant feature of this book is the inclusion of revision questions at the end of each chapter. The aim of these questions is to enhance student understanding and to give lecturers the chance to see the type of questions that they might set for students to test their understanding of the material covered in the book. Multiple choice questions and their solutions, as well as answers to the revision questions, can be found on the website:

One final point about this book is that the rapid changes in the world of finance make it hard for any author to keep abreast of all developments. To this end, the present book is not heavy on institutional detail, preferring to concentrate on the key theories and underlying principles. A thorough understanding of these should enable the reader to understand and interpret developments for themselves.

Keith Pilbeam