... Treasury bonds One security represents the principal payment and a second security represents the interest payments Investors who desire a lump sum payment can choose the PO part Investors ... that are issued by a municipality within a particular state is exempt from state income taxes Interest income earned on bonds issued by a municipality within a city in which the local government ... on a Treasury bond with the same maturity because: Of a risk premium to compensate for default risk Of a liquidity premium to compensate for less liquidity The federal tax exemption of municipal...
... maturity Investors use higher discount rates to discount the future cash flows of riskier securities The value of a high-risk security will be lower than the value of a low-risk security Computing ... Sensitivity of Bond Prices to Interest Rate Movements If bonds are not held to maturity, future prices are most sensitive to changes in the risk-free rate A measurement of bond price sensitivity ... an increase in interest rates 22 Sensitivity of Bond Prices to Interest Rate Movements (cont’d) Bond price elasticity Measures the sensitivity of bond prices to changes in the required...
... Types of investors Individual investors typically hold more then 50 percent of the total equity in a large corporation Ownership is scattered Institutional investors have large equity ... Management typically receives the majority of the votes and can elect its own candidates as directors Background on Stocks (cont’d) Preferred stock Preferred stock represents an equity interest ... increases the demand for and reduces the supply of the security Unfavorable news reduces the demand for and increases the supply of the security Investors continually respond to new information in...
... If interest rates are high, the opportunity cost of holding inventory is high Competition (–) reduces the spread Volume (–) increases liquidity and reduces the risk of a sudden decline in ... volatility 36 Regulation of Stock Trading (cont’d) Securities and Exchange Commission (SEC) The Securities Act of 1933 and the Securities Exchange Act of 1934: Gave the SEC authority to ... shares are purchased 18 Stock Market Transactions (cont’d) Investing in stock indexes (cont’d) Types of ETFs Cubes are traded on the AMEX and represent the Nasdaq 100 index Spiders...
... volatility of the stock over a future period by investors trading the stock 41 Forecasting Stock Price Volatility and Beta (cont’d) Forecasting a stock portfolio’s volatility Portfolio volatility ... time Estimating the firm’s beta Beta reflects the sensitivity of the stock’s return to the market’s overall return Beta is typically measured with monthly or quarterly data over the last ... Investor’s Business Daily Analyst rating services typically charge subscribers between $100 and $600 per year 29 Stock Risk Risk reflects the uncertainty about future returns such that the actual...
... risk reflects the possibility that the counterparty may default on its obligation Sovereign risk reflects the possibility that a county may restrict the convertibility of a particular currency ... of Year 15 Types of Interest Rate Swaps (cont’d) Callable swaps A callable swap provides the party making the fixed payments with the right to terminate the swap prior to its maturity Allows ... feature that allows the fixedfor-floating party to extend the swap period The terms of an extendable swap reflect a price paid for the extendability feature 18 Types of Interest Rate Swaps (cont’d)...
... the stock’s volatility The greater the volatility of the underlying stock, the higher the put option premium Influence of the market price of the put option’s time to maturity The longer the ... volatility can be derived from information about options on that stock index Impact of the September 11 Crisis on the implied volatility of stock indexes The attacks caused more uncertainty ... higher the call option premium Influence of the call option’s time to maturity The longer the call option’s time to maturity, the higher the call option premium 22 Determinants of Stock Option Premiums...
... ($1,000) and thirty-seconds In points ($1,000) and thirtyof a point seconds of a point Minimum price fluctuation One thirty-second (1/32) of a point, or $31.25 per contract One thirty-second (1/32) ... the futures contract Liquidity risk refers to potential price distortions due to a lack of liquidity Credit risk is the risk that a loss will occur because a counterparty defaults on the contract ... with stock index futures (cont’d) Test of suitability of stock index futures Usefulness can be assessed by measuring the sensitivity of the portfolio’s performance to market movements...
... Maturity of money market funds The average maturity is determined by individual asset maturities, weighted according to their relative value In the mid-1970s, the average maturity was relatively ... long By the late 1970s, average maturity had declined to less than half During the 1980s, the average maturity was about 40 days The average maturity has generally increased since the 1980s ... mortgages Can typically be sold on a stock exchange Can be either classified as an equity REIT, a mortgage REIT, or a hybrid 49 Interaction with Other Financial Institutions Type of Financial...
... improvement, mobile homes, and a variety of other personal expenses Consumer loans are often secured by a co-signer or by real property Maturities on personal loans are typically less than five years ... liquidity since all of their funds are from borrowings Overall, the liquidity risk of finance companies is less than that of other financial institutions Interest rate risk Both liability and ... to a maximum length on the loan maturity Finance companies are subject to state regulations on intrastate business Risks Faced by Finance Companies Liquidity risk Finance companies generally...
... Central Liquidity Facility (CLF) Acts as a lender similar to the Fed’s discount window CUs maintain capital, primarily in the form of retained earnings Uses of funds The majority of funds ... criteria used to classify an asset or liability as rate sensitive Some SIs measure the duration of assets and liabilities to determine the imbalance in sensitivity of interest revenue versus expenses ... on deposits to attract more funds The FSLIC was experiencing its own liquidity problems, exacerbating the liquidity problem 34 Savings Institution Crisis (cont’d) Provisions of the FIRREA...
... measurement of risk exists that allows for comparison of various types of risk among all banks Beta is the degree of sensitivity of stock returns to the returns of the stock market as a whole: ... regulations 14 Performance Evaluation of Banks (cont’d) Net income (cont’d) Return on equity (ROE) ROE is affected by the same income statement items that affect ROA as well as the bank’s ... ROE = Return on assets (ROA) × Leverage measure = Net profit after taxes Assets × Assets Equity The leverage measure is the inverse of the capital ratio In recent years, money center banks...
... Managing Liquidity Banks can experience illiquidity when cash outflows exceed cash inflows Banks should maintain the level of liquid assets that will satisfy their liquidity needs but use ... (cont’d) Methods used to reduce interest rate risk Maturity The bank can match each deposit’s maturity with an asset of the same maturity Very difficult to implement because deposits are short ... currency and a liability denominated in a different currency The bank’s profit margin is reduced if the liability currency appreciates against the asset currency Banks risk typically hedge net...
... Banks typically use a 99 percent confidence level 18 Regulation of Capital (cont’d) Use of the value-at-risk method to determine capital requirements (cont’d) Testing The validity is ... Asset quality Regulators determine the capital ratio (capital divided by assets) If banks hold more capital, they can more easily absorb potential losses The FDIC evaluates the quality of the ... specifically rates the bank’s management according to administrative skills, ability to comply with existing regulations, and ability to cope with a changing environment The FDIC also assesses the bank’s...
... interest rates vary among banks and maturity types There is no organized secondary market Depositors will normally forgo a portion of their interest as a penalty for early withdrawal Bank Sources ... Financial Intermediaries Commercial banks serve all types of surplus and deficit units Offer deposit accounts with the size and maturity characteristics desired by surplus units Repackage ... certificates of deposit (NCDs): Are offered by some large banks to corporations Typically have short-term maturities Typically require a minimum deposit of $100,000 Do not have a secondary market...
... 17 Forecasting Exchange Rate Volatility Participants forecast exchange rate volatility to develop a range surrounding their forecast To develop a volatility forecast: Determine the relevant ... relevant period of concern Decide on a method to forecast volatility e.g., historical exchange rate volatility, time series of volatility patterns, implied standard deviations 18 Speculation in Foreign ... rates of major countries were allowed to float Dirty float Freely floating system Background on Foreign Exchange Markets (cont’d) Types of exchange rate systems (cont’d) Pegged exchange...
... $100,000 Has a typical maturity between 20 and 270 days Is issued by financial institutions such as finance companies and bank holding companies Has no active secondary market Is typically not ... commercial paper at various maturities Is typically established for a maturity range from to 90 days Is important because it may influence the maturity that is used by firms that issue CP Is ... (cont’d) Treasury bill auction Investors submit bids on T-bill applications for the maturity of their choice Applications can be obtained from a Federal Reserve district or branch bank Financial...
... Theory (cont’d) Quantity Theory and the Monetarist approach The quantity theory suggests a particular relationship between the money supply and the degree of economic activity in the equation ... 11 Monetary Theory (cont’d) Quantity Theory and the Monetarist approach (cont’d) Velocity represents the ratio of money stock to nominal output Velocity is affected by any factor that influences ... direct relationship between the money supply and prices Under the modern quantity theory of money, the constant quantity assumptions has been relaxed A direct relationship exists between the money...
... others on a rotating basis Goals: promote high employment, economic growth, and price stability Achieved through control of the money supply Decisions on changes in monetary policy are ... declined by 22 percent on October 19, 1987 The Fed loosened the money supply to provide liquidity The Fed monitored bank deposits to ensure there was no run on deposits The Fed monitored credit ... in response to the September 11 attack on the United States The FOMC decided to add liquidity to the banking system to prevent a banking crisis The FOMC left the federal funds rate target...
... Automobiles Household items There is an inverse relationship between the interest rate and the quantity of loanable funds demanded Loanable Funds Theory (cont’d) Business demand for loanable funds ... demand for U.S funds is influenced by the interest rate differential between countries The quantity of U.S loanable funds demanded by foreign governments or firms is inversely related to U.S interest...