This preview shows pages 1–3. Sign up to view the full content.
This preview has intentionally blurred sections. Sign up to view the full version.View Full Document
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 Poors Corporation and Moodys 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....
View Full Document
- Winter '07