Lecture03 - 3-1Interest Rate RiskInstructor: Dr. QU...

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Unformatted text preview: 3-1Interest Rate RiskInstructor: Dr. QU BaozhiPhone: (852) 27887312Email:baozhiqu@cityu.edu.hkOffice: ACAD-P74073-2OverviewThis lecture discusses the interest rate risk associated with financial intermediation:Interest rate determinationRepricing modelMaturity modelDuration model3-3Central Bank and Interest Rate RiskMonetary policy: targeting interest rate.The Central Banks (the Fed in US) monetary policy strategy underlies the movement of interest rates. When the Fed finds it necessary to slow down the economy, it tightens monetary policy by raising interest rates. Conversely, when the Fed finds it necessary to stimulate the economy, it cuts the interest rates.3-4US Rates Cut3-5Central Bank and Interest Rate RiskSince the introduction of the system of linking the HK dollars value to that of the US dollar in October 1983,interest rates in HK have become more volatile.interest rates have become part of the HK monetary policy.A tendency of interest rates to follow those of U.S.3-6Web ResourcesFor information related to central bank policy, visit:Bank for International Settlements: www.bis.orgFederal Reserve Bank: www.federalreserve.govHKMA: www.info.gov.hk/hkmaWeb Surf3-7Present Value Suppose the interest rate is r, then the present value of an amount of $N due next year is given by:P=N/(1+r)r, PN, P 3-8Present Value (Cont.) Suppose the annual interest rate for m-year maturity is rm, then the present value of an amount of $N due in m years is given by:P=N/(1+ rm)mrm, PN, P m, P 3-9Zero-coupon Bonds Zero-coupon bondsare either pure discount bonds upon issue or a Treasury Stripa Treasury bond which has been unbundled and sold in pieces with each piece being a coupon payment or the principal payment. Unbundling coupon bonds is called Coupon Stripping. Coupon stripping suggests that any coupon-bearing bond can be thought of as a portfolio of zero coupon bonds, with each separate payment on the whole bond representing a zero-coupon bond.3-10Yield to Maturity Yield to maturityis one number that is conventionally used to describe the rate at which an assets cash flows are discounted when the discount factor at each date that a cash flow is received is restricted to be the same.Since we know PV, Cis and F, we can calculate y.nntttyFyCPV)1()1(1+++==3-11Term Structure of Interest RatesTerm structure of interest rates, or yield curve, displays the relationship between spot rates of zero-coupon securities and their term to maturity. It can then be used to discount cash flows appropriately. 3-12Term Structure of Interest RatesYTMTime to MaturityTime to MaturityTime to MaturityTime to MaturityYTM3-13Normal Yield Curve3-14Normal Yield CurveNormal Yield Curve: during normal market conditions, wherein investors generally believe that there will be no significant changes in the economy, such as in inflation rates, and that the economy will continue to grow at a normal...
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This note was uploaded on 02/22/2009 for the course ECONOMICS 4313 taught by Professor Tsui during the Spring '09 term at HKU.

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Lecture03 - 3-1Interest Rate RiskInstructor: Dr. QU...

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