Introduction to the economics of financial markets 1st Edition by James Bradfield 0195310632 9780195310634

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ISBN 10: 0195310632

ISBN 13: 9780195310634

Author: James Bradfield

There are many textbooks for business students that provide a systematic, introductory development of the economics of financial markets. However, there are as yet no introductory textbooks aimed at more easily daunted undergraduate liberal arts students. Introduction to the Economics of Financial Markets fills this gap by providing an extremely accessible introductory exposition of how economists analyze both how, and how well, financial markets organize the intertemporal allocation of scarce resources. The central theme is that the function of a system of financial markets is to enable consumers, investors, and managers of firms to effect mutually beneficial intertemporal exchanges. James Bradfield uses the standard concept of economic efficiency (Pareto Optimality) to assess the efficacy of the financial markets. He presents an intuitive, and introductory, understanding of the primary theoretical and empirical models that economists use to analyze financial markets, and then uses these models to discuss implications for public policy. Students who use this text will acquire an understanding of the economics of financial markets that will enable them to read, with some sophistication, articles in the public press about financial markets and about public policy toward those markets. The book is addressed to undergraduate students in the liberal arts, but will also be useful for undergraduate and beginning graduate students in programs of business administration who want an understanding of how economists assess financial markets against the criteria of allocative and informational efficiency.

Introduction to the economics of financial markets 1st Table of contents:

Part I Introduction

1 The Economics of Financial Markets

1.1 The Economic Function of a Financial Market

1.2 The Intended Readers for This Book

1.3 Three Kinds of Trade-Offs

1.4 Mutually Beneficial Intertemporal Exchanges

1.5 Economic Efficiency and Mutually Beneficial Exchanges

1.6 Examples of Market Failures

1.7 Issues in Public Policy

1.8 The Plan of the Book

Problems

Notes

2 Financial Markets and Economic Efficiency

2.1 Financial Securities

2.2 Transaction Costs

2.3 Liquidity

2.4 The Problem of Asymmetric Information

2.5 The Problem of Agency

2.6 Financial Markets and Informational Efficiency

Problems

Notes

Part II Intertemporal Allocation by Consumers and Firms When Future Payments Are Certain

3 The Fundamental Economics of Intertemporal Allocation

3.1 The Plan of the Chapter

3.2 A Primitive Economy with No Trading

3.3 A Primitive Economy with Trading, but with No Markets

3.4 The Assumption That Future Payments Are Known with Certainty Today

3.5 Abstracting from Firms

3.6 The Distinction between Income and Wealth

3.7 Income, Wealth, and Present Values

Problems

Notes

4 The Fisher Diagram for Optimal Intertemporal Allocation

4.1 The Intertemporal Budget Line

4.2 Intertemporal Indifference Curves

4.3 Allocating Wealth to Maximize Intertemporal Utility

4.4 Mutually Beneficial Exchanges

4.5 The Efficient Level of Investment

4.6 The Importance of Informational Efficiency in the Prices of Financial Securities

Notes

5 Maximizing Lifetime Utility in a Firm with Many Shareholders

5.1 The Plan of the Chapter

5.2 A Firm with Many Shareholders

5.3 A Profitable Investment Project

5.4 Financing the New Project

5.5 Conclusion

Problems

Notes

6 A Transition to Models in Which Future Outcomes Are Uncertain

6.1 A Brief Review and the Plan of the Chapter

6.2 Risk and Risk Aversion

6.3 A Synopsis of Modern Portfolio Theory

6.4 A Model of a Firm Whose Future Earnings Are Uncertain: Two Adjacent Farms

6.5 Mutually Beneficial Exchanges: A Contractual Claim and a Residual Claim

6.6 The Equilibrium Prices of the Bond and the Stock

6.7 Conclusion

Problems

Notes

Part III Rates of Return as Random Variables

7 Probabilistic Models

7.1 The Objectives of Using Probabilistic Models

7.2 Rates of Return and Prices

7.3 Rates of Return as Random Variables

7.4 Normal Probability Distributions

7.5 A Joint Probability Distribution for Two Discrete Random Variables 142

7.6 A Summary Thus Far

7.7 The Effect of the Price of a Security on the Expected Value of Its Rate of Return

7.8 The Effect of the Price of a Security on the Standard Deviation of Its Rate of Return

7.9 A Linear Model of the Rate of Return

7.10 Regression Lines and Characteristic Lines

7.11 The Parameter ß as the Quantity of Risk in Security i

7.12 Correlation

7.13 Summary

Problems

Notes

Part IV Portfolio Theory and Capital Asset Pricing Theory

8 Portfolio Theory

8.1 Introduction

8.2 Portfolios as Synthetic Securities

8.3 Portfolios Containing Two Risky Securities

8.4 The Trade-Off between the Expected Value and the Standard Deviation of the Rate of Return on a Portfolio That Contains Two Securities

8.5 A Simple Numerical Example to Show the Effect of ρAB on the Trade-Off between Expected Return and Standard Deviation

8.6 The Special Cases of Perfect Positive and Perfect Negative Correlation

8.7 Trade-Offs between Expected Return and Standard Deviation for Portfolios That Contain N Risky Securities

8.8 Summary

Problems

Notes

9 The Capital Asset Pricing Model

9.1 Introduction

9.2 Capital Market Theory and Portfolio Theory

9.3 The Microeconomic Foundations of the CAPM

9.4 The Three Equations of the CAPM

9.5 A Summary of the Intuitive Introduction to the CAPM

9.6 The Derivation of the Capital Market Line

9.7 The Derivation of the Security Market Line

9.8 Interpreting ßi as the Marginal Effect of Security i on the Total Risk in the Investor’s Portfolio

9.9 Summary

Problem

Notes

10 Multifactor Models for Pricing Securities

10.1 Introduction

10.2 Analogies and an Important Distinction between the Capital Asset Pricing Model and Multifactor Models

10.3 A Hypothetical Two-Factor Asset Pricing Model

10.4 The Three-Factor Model of Fama and French

10.5 The Five-Factor Model of Fama and French

10.6 The Arbitrage Pricing Theory

10.7 Summary

Appendix: Estimating the Values of β and λ for a Two-Factor Model

Problem

Notes

Part V The Informational and Allocative Efficiency of Financial Markets: The Concepts

11 The Efficient Markets Hypothesis

11.1 Introduction

11.2 Informational Efficiency, Rationality, and the Joint Hypothesis

11.3 A Simple Example of Informational Efficiency

11.4 A Second Example of Informational Efficiency: Predictability of Returns—Bubbles or Rational Variations of Expected Returns?

11.5 Informational Efficiency and the Predictability of Returns

11.6 Informational Efficiency and the Speed of Adjustment of Prices to Public Information

11.7 Informational Efficiency and the Speed of Adjustment of Prices to Private Information

11.8 Information Trading, Liquidity Trading, and the Cost of Capital for a Firm

11.9 Distinguishing among Equilibrium, Stability, and Volatility

11.10 Conclusion

Appendix: The Effect of a Unit Tax in a Competitive Industry

Notes

12 Event Studies

12.1 Introduction

12.2 Risk-Adjusted Residuals and the Adjustment of Prices to New Information

12.3 The Structure of an Event Study

12.4 Examples of Event Studies

12.5 Example 1: The Effect of Antitrust Action against Microsoft

12.6 Example 2: Regulatory Rents in the Motor Carrier Industry

12.7 Example 3: Merger Announcements and Insider Trading

12.8 Example 4: Sudden Changes in Australian Native Property Rights 305

12.9 Example 5: Gradual Incorporation of Information about Proposed Reforms of Health Care into the Prices of Pharmaceutical Stocks

12.10 Conclusion

Notes

Part VI The Informational and Allocative Efficiency of Financial Markets: Applications

13 Capital Structure

13.1 Introduction

13.2 What Is Capital Structure?

13.3 The Economic Significance of a Firm’s Capital Structure

13.4 Capital Structure and Mutually Beneficial Exchanges between Investors Who Differ in Their Tolerances for Risk

13.5 A Problem of Agency: Enforcing Payouts of Free Cash Flows

13.6 A Problem of Agency: Reallocating Resources When Consumers’ Preferences Change

13.7 A Problem of Agency: Asset Substitution

13.8 Economic Inefficiencies Created by Asymmetric Information

13.9 The Effect of Capital Structure on the Equilibrium Values of Price and Quantity in a Duopoly

13.10 The Effect of Capital Structure on the Firm’s Reputation for the Quality of a Durable Product

13.11 Conclusion

Appendix

Problems

Notes

14 Insider Trading

14.1 Introduction

14.2 The Definition of Insider Trading

14.3 Who Owns Inside Information?

14.4 The Economic Effect of Insider Trading: A General Treatment

14.5 The Effect of Insider Trading on Mitigating Problems of Agency

14.6 The Effect of Insider Trading on Protecting the Value of a Firm’s Confidential Information

14.7 The Effect of Insider Trading on the Firm’s Cost of Capital through the Effect on Liquidity

14.8 The Effect of Insider Trading on the Trade-Off between Insiders and Informed Investors in Producing Informative Prices

14.9 Implications for the Regulation of Insider Trading

14.10 Summary

Notes

15 Options

15.1 Introduction

15.2 Call Options

15.3 Put Options

15.4 A Simple Model of the Equilibrium Price of a Call Option

15.5 The Black-Scholes Option Pricing Formula

15.6 The Put-Call Parity

15.7 Homemade Options

15.8 Introduction to Implicit Options

15.9 Implicit Options in a Leveraged Firm

15.10 An Implicit Option on a Postponable and Irreversible Investment Project

15.11 Summary

Appendix: Continuous Compounding

Problems

Notes

16 Futures Contracts

16.1 Introduction

16.2 Futures Contracts as Financial Securities

16.3 Futures Contracts and the Efficient Allocation of Risk

16.4 The Futures Price, the Spot Price, and the Future Price

16.5 The Long Side and the Short Side of a Futures Contract

16.6 Futures Contracts as Financial Securities

16.7 Futures Contracts as Transmitters of Information about the Future Values of Spot Prices

16.8 Investment, Speculation, and Hedging

16.9 Futures Prices as Predictors of Future Values of Spot Prices

16.10 Conclusion

Notes

17 Additional Topics in the Economics of Financial Markets

17.1 Bonds

17.2 Initial Public Offerings

17.3 Mutual Funds

17.4 Behavioral Finance

17.5 Market Microstructure

17.6 Financial Derivatives

17.7 Corporate Takeovers

17.8 Signaling with Dividends

17.9 Bibliographies

Note

18 Summary and Conclusion

18.1 An Overview

18.2 Efficiency

18.3 Asset Pricing Models

18.4 Market Imperfections

18.5 Derivatives

18.6 Implications for Public Policy

18.7 A Final Word

Notes

Answers to Problems

Glossary

Bibliography of Nobel Laureates

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