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ECO 129 Exam II review

ECO 129 Exam II review - EXAM II GUIDELINES[Erdem Aktug...

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EXAM II – GUIDELINES [Erdem Aktug] CHAPTER 7 The Risk and the Term Structure of Interest Rates ‐ Upward Sloping, Flat, Inverted Yield Curve>connection with the economic outlook, expectations about the future short term interest rates? Expectations theory, liquidity premium theory, market segmentations t heory. US Treasury Bonds are Benchmark Bonds Risk Spread: US Treasury Bond yield + Default Risk Premium Term Structure of Interest Rates- The relationship among bonds with the same risk characteristics but different maturities. 1. Interest rates of different maturities tend to move together 2. Yields on short term bonds are more volatile than yields on long-term bonds 3. Long term yields tend to be higher than short term yields Expectations Hypothesis- Investors consider bonds of different maturities to be perfect substitutes Liquidity Premium Theory – interest rates of different maturities will move together and that yields on short term bonds will be more volatile than yields on long term bonds. THE YIELD CURVE WILL NORMALLY SLOPE UPWARD Market Segmentations Theory- Bonds of different maturities are not substitutes. -Greater interest rate risk at higher maturity, Lower liquidity. Adaptive Expectations – Only using past values ‐ Buy and Hold vs. Roll‐over strategy? i.e. how do you calculate the 1 year interest rate one year from no w (future short term 1 yr int. rate)if you know current 2 year int. rate(5%), and current 1 year int.rate (4% )? How does the picture change in the case of pure expectations vs. case of liquidity premium? -Buy and Hold: Purchase Security and hold onto it until the end of its maturity. -Roll-over strategy: Purchase segmented securities broken up over the time you wish to invest. ‐ Mortgage Markets? What is a Sub‐prime Mortgage? Securitization, MBS, CDO? Key issues & problem s? ‐ Review PS2 Questions 9‐13. Try Conceptual & Analytical Problems (in book) 5,6,8,10,18. CHAPTER 8 Stocks, Stock Markets, and Market Efficiency ‐ How are Stock Indexes calculated? Which one is more volatile? S&P500, DJIA, or Nasdaq?
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Dow Jones Industrial Average- eleven stocks, price-weighted average – gives greater weight to shares with higher prices Standard and Poor’s 500 – 500 stocks, value weighted index- each firms stock price receives a weight equal to its total market value. (market capitalization- total market value) Nasdaq Composite- value weighted index of over 5000 companies OTC ‐ “Dividend Discount Model” > calculate stock price given the dividends, growth, expected return… Stock Prices are high when: 1. Current dividends are high Dtoday is high 2. Dividends are expected to grow quickly g is high 3. The risk free rate is low rf is low 4. The risk premium on equity is low rp is low ‐ Rational vs. Adaptive Expectations? Efficient Markets Hypothesis? Random‐Walk? Equity Premium Pu zzle?
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