Class 7 - Econ 350 U.S. Financial Systems, Markets and...

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Econ 350 U.S. Financial Systems, Markets and Institutions Class 7 Econ 350 U.S. Financial Systems, Markets, and Institutions Class 7: Interest rates – structure and yield curves Today we will examine the structure of interest rates and yield curves. Different types of bonds pay different rates of interest depending on their characteristics. For instance, long-term bonds tend to pay higher interest than short-term bonds. Treasury bonds pay higher interest than municipal bonds, and corporate bonds pay higher interest than government bonds of similar maturities. How do we explain these patterns? Why are investors willing to accept different rates of returns on different categories of investments? We explore these issues in class today. A closely related concept is that of a yield curve. A yield curve shows how interest rates change as the maturity of a security increases. Treasury bonds, notes and bills are often the subjects of yield curves. As we will see, a controversy has arisen lately over the implications of the recent flattening and then steepening of the yield curve. Yield curves typically slope upward, and several models have been developed to help to explain the slope of the yield curve. The slope of the yield curve has important implications for the rate of expected inflation in the economy and for future economic growth. Course Objectives After today’s class, you should -- be familiar with how to read bond prices in newspapers. -- be able to explain the term-, risk-, and tax- structures of interest rates. -- know what yield curves are and why they are important in financial analysis. -- understand why yield curves are almost always upward-sloping. -- appreciate the controversy over the recent flattening of the yield curve. Reading the bond pages Information about the structure of interest rates can often be found in the financial pages of any major newspaper. There is often information about the yields, coupon rates and maturities of corporate and government bonds. Investors use this information to assess the profitability of investment opportunities, and economists and policymakers use this information to help assess the state of the economy. Mishkin provides a good review of reading bond pages and how to understand the structure of interest rates. Figure 7-1 shows the bond tables for Treasury Bills, and then Notes and Bonds that were listed in the New York Times of June 8, 2005 for the closing market prices on June 7. The first table lists Treasury bills. These are discount bonds, so a coupon rate is not listed. Since the bonds do not vary by coupon payment, they are listed solely by their date of maturity. The bid column shows the discount yield for people selling to dealers, while the ask column is the discount yield buying from dealers. The bid is what the dealer is willing to pay, while the ask is the price the dealer is willing to sell for. The difference is the spread, or profits earned by dealers. The last two columns show the 50
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This note was uploaded on 05/09/2009 for the course ECON 350 taught by Professor Christianson during the Spring '08 term at Binghamton.

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Class 7 - Econ 350 U.S. Financial Systems, Markets and...

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