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Unformatted text preview: 22 ECON110B II. Financial Markets and Expectations • More realistic menu of nonmoney assets: Short-term bonds, long-term bonds and stocks • On the role expectations play in the determination of bond and stock prices • To look at the determination of bond prices and bond yields - How bond prices and yields depend on current and expected future short-term interest rates - How we can use the yield curve to learn about the expected course of future short-term interest rates • To look at the determination of stock prices - How stock prices depend on current and expected future profits, as well as current and expected future interest rates - How movements in economic activity affect stock prices • To discusses fads and bubbles in the stock market 1. Bond prices and bond yields 1) Fundamentals about bonds a. Two basic dimensions of bonds 23 i) Default risk - The risk that the issuer of the bond will not pay back the full amount promised by the bond ii) Maturity - The length of time over which the bond promises to make payments to the holder of the bond b. Yield to maturity (or Yield) - To have a price and an associated interest rate - Short-term interest rates: yields on bonds with a short maturity, typically a year or less - Long-term interest rates: yields on bonds with longer maturity c. Yield curve (or Term structure of interest rates) - The relation between maturity and yield - To trace graphically how the yield depends on the maturity of a bond U.S. Yield Curves: November 1, 2000, and June 1, 2001 24 d. Downward sloping or upward sloping - November 2000: downward sloping - June 2001: upward sloping - Why were long-term interest rates slightly lower than short-term interest rates in November 2000 but higher than short-term interest rates in June 2001? e. Fundamental about bond markets - Government bonds are bonds issued by government agencies - Corporate bonds are bonds issued by firms - Bond ratings are issued by Standard and Poor’s Corporation and Moody’s Investors Service- The risk premium is the difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest rating - Bonds with high default risk are often called junk bonds 25- Bonds that promise a single payment at maturity are called discount bonds . The single payment is called the face value of the bond - Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds . The payments are called coupon payments- The ratio of the coupon payments to the face value of the bond is called the coupon rate- The current yield is the ratio of the coupon payment to the price of the bond - The life of a bond is the amount of time left until the bond matures - U.S. government bonds classified by maturity: Treasury bills, or T-bills: Up to one year....
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This note was uploaded on 09/18/2008 for the course ECON 100B taught by Professor Rauch during the Winter '07 term at UCSD.
- Winter '07