Capital Markets Institutions and Instruments

The revolution that swept through the world financial markets was aptly described in 1985 by a noted economist, Henry Kaufman: If a modern-day Rip Van Winkle had fallen asleep twenty years ago, or for that matter even ten years back, on awakening today, he would be astonished as to what has happened in the financial markets. Instead of a world of iso- lated national capital markets and a preponderance of fixed-rate financing, he would discover a world of highly integrated capital markets, an extensive array of financing instruments, and new methods of addressing market risk. The purpose of this book is to describe the wide range of instruments for financing, investing, and controlling risk available in today's financial markets. New financial instruments are not created simply because someone on Wall Street believes that it would be "fun" to introduce an instrument with more "bells and whistles" than existing instruments. The demand for new instruments is driven by the needs of borrowers and investors based on their asset/liability management situation, regulatory constraints (if any), financial accounting considerations, and tax considerations. For these reasons, to comprehend the financial innovations that have occurred and are expected to occur in the future, a general understanding of the asset/liability management problem of major institutional investors is required. Therefore, in addition to coverage of the markets for all financial instruments, we provide an overview of the asset/liability management issues faced by major institutional investors and the strategies they employ. We believe that the coverage provided in this book on the institutional investors and financial instruments is as up-to-date as possible in a market facing rapid changes in the characteristics of the players and those making the rules as to how the game can be played. New financial instruments are introduced on a regular basis; however, armed with an understanding of the needs of borrowers and institutional investors and the attributes of existing financial instruments, the reader will be able to recognize the contribution made by a new financial instrument. The first edition of this book was published in 1992. At the time, the book deviated in several significant ways from the traditional capital markets textbooks, notably in its coverage of derivative markets (futures, options, swaps, etc.). These markets are an integral part of the global capital market. They are not--as often categorized by the popular press and some of our less-informed congressional representatives and regulators--"exotic" markets. These instruments provide a mechanism by which market participants can control risk--borrowers can control borrowing costs and investors can control the market risk of their portfolio. It is safe to say that without the derivative markets, an efficient global capital market would be impossible. In addition, it is important to appreciate the basic principles of options not only as a stand-alone instrument, but because many financial instruments have embedded options. Also, the liabilities of many financial institutions contain embedded options. Thus, it is difficult to appreciate the complex nature of assets and liabilities without understanding the fundamentals of option theory. Although we recognize that many colleges offer a specialized course in derivative markets, our purpose in the first edition was not to delve deeply into the various trading strategies and the nuances of pricing models that characterize such a course. Instead, we provided the fundamentals of the role of these instruments in financial markets, the principles of pricing them, and a general description of how they are used by market participants to control risk. A special feature of the book at the time was the extensive coverage of the mortgage market andFabozzi, Frank J. is the author of 'Capital Markets Institutions and Instruments', published 2002 under ISBN 9780130673343 and ISBN 013067334X.