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1、Chapter 4 Understanding Interest RatesChapter 4 Understanding Interest RatesChapter5 The Behavior of Interest RatesChapter5 The Behavior of Interest RatesChapter6 The Risk and Term Structure Chapter6 The Risk and Term Structure of Interest Rates of Interest RatesChapter 7 The Stock MarketChapter 7 T

2、he Stock Market1 I. Measuring Interest Rate 1. Cash flow: streams of cash payments.2. Present Value(PV)and Future Value(FV): PV: Thecurrent worthof a future stream of cash flows. FV: The worth of a certain amount of current funds in the future. 223Let = .10In one year $100 X (1+ 0.10) = $110 In two

3、years $110 X (1 + 0.10) = $121or 100 X (1 + 0.10)In three years $121 X (1 + 0.10) = $133or 100 X (1 + 0.10)In years$100 X (1 + ) nini3nPV = todays (present) valueCF = future cash flow (payment) = the interest rateCFPV = (1 + )ii4$100$100Year01PV1002$100$100n100/(1+i)100/(1+i)2100/(1+i)nCannot direct

4、ly compare payments scheduled in different points in the time line5Simple Loan: principle and interest must be repaid at the maturity date.Fixed Payment Loan: Must be repaid by making the same payment every period，consisting of part of principle and interest for a set number of years.Coupon Bond: pa

5、ys the bond holder a fixed interest payment every year until the maturity date, when the face value is repaid.Discount Bond (zero coupon bond):is bought at a price below its face value, which is repaid at the maturity date. 67 Early Coupon bond Early Coupon bond (County of Harrison in the State of M

6、ississippi) (County of Harrison in the State of Mississippi)Whats YTM: The interest rate that equates the present value of cash flow payments received from a debt instrument with its value today.YTM is also called internal rate of return(IRR)How to calculate YTM ?81PV = amount borrowed = $100CF = ca

7、sh flow in one year = $110 = number of years = 1$110$100 = (1 + )(1 + ) $100 = $110$110(1 + ) = $100 = 0.10 = 10%For simple loans, the simple interest rate equniiiials theyield to maturity923The same cash flow payment every period throughout the life of the loanLV = loan valueFP = fixed yearly payme

8、nt = number of years until maturityFPFPFPFPLV = . . . +1 + (1 + )(1 + )(1 + )nniiii1023Using the same strategy used for the fixed-payment loan:P = price of coupon bondC = yearly coupon paymentF = face value of the bond = years to maturity dateCCCCFP = . . . +1+(1+ )(1+ )(1+ )(1nniiii+ )ni11When the

9、coupon bond is priced at its face value, the YTM equals the coupon rateThe price of a coupon bond and the YTM are negatively relatedThe YTM is greater than the coupon rate when the bond price is below its face value12 For any one year discount bondi = F - PPF = Face value of the discount bondP = cur

10、rent price of the discount bondThe yield to maturity equals the increasein price over the year divided by the initial price.As with a coupon bond, the yield to maturity is negatively related to the current bond price.13 The payments to the owner plus the change in valueexpressed as a fraction of the

11、 purchase priceRET = CPt + Pt1 - PtPtRET = return from holding the bond from time t to time t + 1Pt = price of bond at time tPt1 = price of the bond at time t + 1C = coupon payment CPt = current yield = ic Pt1 - PtPt = rate of capital gain = g14The return equals the YTM only if the holding period eq

12、uals the time to maturityA rise in interest rates is associated with a fall in bond prices, resulting in a capital loss if time to maturity is longer than the holding periodThe more distant a bonds maturity, the greater the size of the percentage price change associated with an interest-rate change1

13、5The more distant a bonds maturity, the lower the rate of return that occurs as a result of an increase in the interest rateEven if a bond has a substantial initial interest rate, its return can be negative if interest rates rise. 1617It is the riskiness of an assets return that result from interest

14、-rate changesPrices and returns for long-term bonds are more volatile than those for shorter-term bondsThere is no interest-rate risk for any bond whose time to maturity matches the holding period181.Real and Nominal Interest RatesNominal interest rate makes no allowance for inflationReal interest r

15、ate is adjusted for changes in price level so it more accurately reflects the cost of borrowingEx ante real interest rate is adjusted for expected changes in the price levelEx post real interest rate is adjusted for actual changes in the price level19 = nominal interest rate = real interest rate = e

16、xpected inflation rateWhen the real interest rate is low,there are greater incentives to borrow and fewer incentives to lend.The real intererreiiii est rate is a better indicator of the incentives toborrow and lend.20212. fixed rate and floating rate2. fixed rate and floating ratefixed rate :The rat

17、e is fixed during the whole fixed rate :The rate is fixed during the whole credit period.credit period.floating rate: The rate is adjustable in terms of floating rate: The rate is adjustable in terms of the market condition during the credit period. the market condition during the credit period.3. m

18、arket rate and official rate3. market rate and official rate market rate: the rate is determined by supply and market rate: the rate is determined by supply and demand in financial market.demand in financial market.official rate: the rate is determined by the official rate: the rate is determined by

19、 the central bank or government.central bank or government.4. Short-term rate and long term rate4. Short-term rate and long term rate5. Common rate and favorable rate5. Common rate and favorable rate2223 Source: 6.benchmark rate and other rates6.benchmark rate and other rates benchmark rate: the rat

20、e which play a very benchmark rate: the rate which play a very important role in the interest rate system.important role in the interest rate system. features: features: it can direct other rates. it can direct other rates. easy to be controlled by the central bank. easy to be controlled by the cent

21、ral bank. a kind of short-term rate. a kind of short-term rate. for example: Federal Funds Rate for example: Federal Funds Rate24251.Rate and Saving: substitute effect: r S income effect: r S 2.Rate and Consumption demand(-): r consumer loans Cd3. Rate and Investment demand(-) r Id 264. Rate and Loa

22、n size r borrowing cost Ld return of loan Ls5. Rate and price level (-) r Cd ,Id Ad P Rate and asset price: (-) Rate and International capital flow Questions: Questions: which factors influence interest which factors influence interest rates?rates? how the overall level of interest how the overall l

23、evel of interest rates is rates is determined? determined? Train of thoughts : Train of thoughts : interest rates are negatively interest rates are negatively related to the price of bondsrelated to the price of bonds make use of supply and make use of supply and demand analysis for bonds demand ana

24、lysis for bonds market and money markets to market and money markets to examine how interest rate examine how interest rate change. change. 2728 1. Determinants of Asset DemandWealth (+)Expected Return (+)Risk (-)Liquidity(+)I.Viewpoint of Bond Demand and SupplyI.Viewpoint of Bond Demand and SupplyA

25、t lower prices (higher i),the quantity demanded of bonds is higherAt lower prices (higher i), the quantity supplied of bonds is lowerMarket Equilibrium:Bd = Bs defines the equilibrium price and interest rate. When Bd Bs , price will rise and interest rate will fallWhen Bd Bs , price will fall and in

26、terest rate will rise2930(1)Shifts in the Demand for Bonds(1)Shifts in the Demand for BondsWealth : the demand curve shifts to the right Wealth : the demand curve shifts to the right Expected Returns (expected i is lower): Expected Returns (expected i is lower): demand for long-term bonds increase,

27、the demand for long-term bonds increase, the demand curve shift to the rightdemand curve shift to the rightExpected Inflation : lowers the expected Expected Inflation : lowers the expected return for bonds, the demand curve shift to return for bonds, the demand curve shift to the leftthe leftRisk :

28、the demand curve shift to the leftRisk : the demand curve shift to the leftLiquidity : the demand curve shift to the rightLiquidity : the demand curve shift to the right31Expected profitability of investment opportunities : the supply curve shifts to the rightExpected inflation : the supply curve sh

29、ift to the rightGovernment budget : increased budget deficits shift the supply curve to the right3233(3) Summary:(3) Summary: factors which affect interest rate factors which affect interest rate 1. Expected inflation (+) :Fisher Effect2. Business cycle expansion: (+)3. 3. Liquidity : (-)4. 4. Expec

30、ted return :(-)5. 5. Risk: (+)6. 6. Government budget: (+)343536 Source: Federal Reserve: .37Keynesian model that determines the equilibrium interest ratein terms of the supply of and demand for money. There are two main categories of assets that people use to storetheir wealth: money and bossddsdsd

31、sdsdnds.Total wealth in the economy = B M = B + MRearranging: B - B = M - MIf the market for money is in equilibrium (M = M ),then the bond market is also in equilibrium (B = B ).38Money Demand : As the interest rate increases, the opportunity cost of holding money increases and the relative expecte

32、d return of money decreases, the money demand decreases.Money Supply Assume that the supply of money is controlled by the central bank39John Maynard Keynes40Income Effect: a higher level of income causes the demand for money increase and the demand curve shift to the right, interest rate increases.P

33、rice-Level Effect: a rise in the price level causes the demand for money increase and the demand curve shift to the right ,interest rate increases. Shifts in the Supply of MoneyAn increase in the money supply will shift the supply curve to the right, interest rate will decline (Liquidity effect)4142

34、43Liquidity effect: an increase of Ms will lower i.Income effect : an increase of Ms leads to higher income, thus increase the i. Price-Level effect: predicts an increase of Ms leads to a rise in i in response to the rise in the price level Expected-Inflation effect: an increase in the Ms lead peopl

35、e to expect a higher price level in the future, thus increase the i. 4445Sources: Federal Reserve: .46Risk Structure of Interest RatesRisk Structure of Interest Rates Bonds with the same maturity have Bonds with the same maturity have different interest rates due to:different interest rates due to:D

36、efault riskDefault riskLiquidity Liquidity Tax considerationsTax considerations47 Sources: Board of Governors of the Federal Reserve System, Banking and Monetary Statistics, 19411970; Federal Reserve: .48 1.Default risk: probability that the issuer of the bond is unable or unwilling to make interest

37、 payments or pay off the face valueDefault-free bonds Risk premium: the spread between the interest rates on bonds with default risk and the interest rates on Treasury bonds (same maturity) An increase in default risk of a bond will raise the risk premium49505152 2. Liquidity: the relative ease with

38、 which an asset can be converted into cashCost of selling a bondNumber of buyers/sellers in a bond marketThe i of less liquidity bond is higher than that of more liquidity bond. 3. Income tax considerationsInterest payments on municipal bonds are exempt from federal income taxes, so the i on municip

39、al bonds is lower than the i on TB.5354Bonds with identical risk, liquidity, and tax characteristics may have different interest rates because the time remaining to maturity is different55 A plot of the yield on bonds with differing terms to maturity but the same risk, liquidity and tax consideratio

40、ns.Upward-sloping: long-term rates are above short-term ratesFlat: short- and long-term rates are the sameInverted: long-term rates are below short-term rates56Yield Curve of Chinese Inter-Bank Yield Curve of Chinese Inter-Bank Treasury Bonds Treasury Bonds 57 1) Interest rates on bonds of different

41、 maturities move together over time 2) When short-term interest rates are low, yield curves are more likely to have an upward slope; when short-term rates are high, yield curves are more likely to slope downward and be inverted 3) Yield curves almost always slope upward58 1) Expectations theory expl

42、ains the first two facts but not the third 2) Segmented markets theory explains fact three but not the first two 3) Liquidity premium theory combines the two theories to explain all three facts59Sources: Federal Reserve: .60 The i on a long-term bond will equal an average of the short-term i that pe

43、ople expect to occur over the life of the long-term bond. Assuming: Buyers of bonds do not prefer bonds of one maturity over anotherBond holders consider bonds with different maturities to be perfect substitutes6112For an investment of $1= todays interest rate on a one-period bond= interest rate on

44、a one-period bond expected for next period= todays interest rate on the two-period bondtettiii622222222222Expected return over the two periods from investing $1 in thetwo-period bond and holding it for the two periods(1 + )(1 + ) 11 2()12()Since () is very smallthe expected retttttttiiiiiii 2turn fo

45、r holding the two-period bond for two periods is2ti631111111If two one-period bonds are bought with the $1 investment(1)(1) 11() 1()() is extremely smallSimplifying we getetteetttteettttettettiiiii iiii ii iii642112Both bonds will be held only if the expected returns are equal22The two-period rate m

46、ust equal the average of the two one-period ratesFor bonds with longer maturitiesetttetttttntiiiiiiiii12(1).The -period interest rate equals the average of the one-periodinterest rates expected to occur over the -period life of the bondeeettniinnn65uExplains why the term structure of interest rates

47、changes at different timesuExplains why interest rates on bonds with different maturities move together over time (fact 1)uExplains why yield curves tend to slope up when short-term rates are low and slope down when short-term rates are high (fact 2)uCannot explain why yield curves usually slope upw

48、ard (fact 3)66 The interest rate for each bond with a different maturity is determined by the demand for and supply of that bond Assuming:Bonds of different maturities are not substitutes at allInvestors have preferences for bonds of one maturity over anotherIf investors generally prefer bonds with

49、shorter maturities that have less interest-rate risk, it explains why yield curves usually slope upward (fact 3) Flaw: cant explain fact 1,2671.Liquidity Premium theory: The interest rate on a long-term bond will equal an average of short-term interest rates expected to occur over the life of the lo

50、ng-term bond plus a liquidity premium of that bond Assuming:Bonds of different maturities are partial substitutes68 intitit1eit2e.it(n1)enlntwhere lnt is the liquidity premium for the n-period bond at time tlnt is always positiveRises with the term to maturity69Investors have a preference for bonds

51、of one maturity over anotherThey will be willing to buy bonds of different maturities only if they earn a somewhat higher expected returnInvestors are likely to prefer short-term bonds over longer-term bonds 7071Interest rates on different maturity bonds move together over time; explained by the fir

52、st term in the equationYield curves tend to slope upward when short-term rates are low and to be inverted when short-term rates are high; explained by the liquidity premium term in the first case and by a low expected average in the second caseYield curves typically slope upward; explained by a larg

53、er liquidity premium as the term to maturity lengthens7273Sources: Federal Reserve Bank of St. Louis; U.S. Financial Data, various issues; Wall Street Journal, various dates.7475Chapter 7 The Stock Market Questions:Whats the determinants of stock prices? Whats P/E ration and its role? Whats stock pr

54、ice Index? 110011(1)(1)= the current price of the stock = the dividend paid at the end of year 1 = the required return on investment in equity = the sale price of the stock at the end of the eeeDivPPkkPDivkPfirst period1. One-Period Valuation Model1. One-Period Valuation Model7612012001The value of

55、stock today is the present value of all future cash flows.(1)(1)(1)(1)If is far in the future, it will not affect (1)The price of the nnnneeeenttteDPDDPkkkkPPDPkstock is determined only by the present value ofthe future dividend stream77 P0D0(1g)(keg)D1(keg)D0= the most recent dividend paidg = the expected constant growth rate in dividendske = the required return on an investment in equityDividends are assumed to continue growing at a constant rate foreverThe growth rat