This preview shows pages 1–3. Sign up to view the full content.
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 longterm 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.
Rollover strategy: Purchase segmented securities broken up over the time you wish to invest.
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?
This preview has intentionally blurred sections. Sign up to view the full version.
View Full Document Dow Jones Industrial Average eleven stocks, priceweighted 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?
Adaptive Expectations Forecasting based only on past data
This is the end of the preview. Sign up
to
access the rest of the document.
This note was uploaded on 04/07/2008 for the course ECO 001 taught by Professor Gunter during the Spring '06 term at Lehigh University .
 Spring '06
 GUNTER
 Economics, Interest Rates

Click to edit the document details