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Econ 311 notes pt. 2
End of Ch. 6 (I missed the first part of these notes)
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3 theories of the term structure of interest rates
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Expectation theory
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Segmented markets theory
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Liquidity premium theory
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Expectation theory
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Bond investors view bonds of different maturity as perfect substitutes
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The yield on lonfterm bonds is the avg. of the current and expected future yield on sort term bonds
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Segmented Markets theory
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Assume that bond investors do not consider bonds of different maturities to be substitutes at all
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Assume that there is a separate market for bonds of each maturity, and that the expected return on bonds
of one maturity have no effect on the demand for bonds of other maturities
o
Since bond investors tend to prefer shorter maturities, shorterm yields are typically lower than long term
yields
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Liquidity premium theory
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Assume that bonds of different maturities are substitutes, but not prefect substitutes
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Assume investors prefer shorter maturities to longer maturities
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Yeild curve and inflation
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Upward slope yield curve may suggest future inflation
Assume real int. rates expected to remain unchanged
Upward sloping yield curve suggests future short term nominal rates expected to increase
Higher nominal rates and constant real rates suggest greater expected inflation
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That is, if people are anticipating higher future inflation, we would expect to observe an upward
sloping yield curve
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Yield curves and recession
o
A downward sloping or inverted yield curve is often a leading indicator of recession
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The inverted yield curve suggests expectations of lower future short term int. rates
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This suggests people are expecting the demand for credit (Loanable funds) to decrease
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Decreased demand for credit is consistent with weak economic conditions
Ch.7
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Theories of stock valuation
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In general, the value of an asset is the present value of all future cash flows the asset will generate
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Stock valuation model
Oneperiod valuation model
Generalized dividend valuation model
Godon growth model
Capital asset pricing model
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OnePeriod Valuation Model
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Generalized dividend valuation model
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In this model, the price of a stock is determined only by the present value of its dividends
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Godon growth model
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Assumes constant dividend growth
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Discount Factor
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Is the required return on equity investments
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the required return on a stock is based on a risk free return plus a risk premium associated with owning
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This note was uploaded on 03/26/2008 for the course ECON 311 taught by Professor Edwardson during the Spring '08 term at Texas A&M.
 Spring '08
 Edwardson
 Interest Rates

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