Post on 07-Jul-2018
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Types o Financial MarketsPhysical Asset versus FinancialAsset Market
Money Market versus CapitalMarket
Primary versus Secondary MarketOpen versus Negotiated Market
Spot versus Futures Market
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Recent Trends in Financial MarketsGlobalization
erivatives
Stock O!nership Patterns
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Types o Financial Transactionsirect trans"er
#ndirect trans"er $hrough an investment bankinghouse
$hrough a %nancial intermediary
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The !tock Market Organized &'changes versus Over(the(Counter Market
N)S& versus Nasda* system
i+erences are narro!ing
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International Financial Markets&urodollar markets
ollars held outside the ,-S-
Mostly &urope. but also else!here
#nternational bondsForeign bonds/ Sold by "oreign borro!er.but denominated in the currency o" thecountry o" issue-
&urobonds/ Sold in country other than theone in !hose currency it is denominated-
#nternational stocksA0s/ Certi%cates representing o!nershipo" "oreign stock held in trust-
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"hat #arious Types o Risks $rise"hen Investing %verseas&Country risk/ Arises "rom investing or
doing business in a particular country- #tdepends on the country1s economic.political. and social environment-
&'change rate risk/ #" investment is
denominated in a currency other than thedollar. the investment1s value !ill dependon !hat happens to e'change rate-
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The 'ost o Money2hat do !e call the price. or cost.o" debt capital3
2hat do !e call the price. or cost.o" e*uity capital3
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Fundamental Factors $ecting the'ost o Money
Production opportunities
$ime pre"erences "or consumption
0isk
&'pected in4ation
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k* = Real risk-free rate. T-bond rate if no inflation; 1% to 4%.
= Any nominal rate.
= Rate on Treasury securities.
k
kRF
Real versus (ominal Rates
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The )eterminants o Market Interest Rates
2here/
k 5 0e*uired rate o" return on a debt security-
k6 5 0eal risk("ree rate-
#P 5 #n4ation premium-0P 5 e"ault risk premium-
7P 5 7i*uidity premium-
M0P 5 Maturity risk premium-
k * k+ I- )R- .- MR-
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-remiums $dded to k+ or )ierentTypes o )ebt
S$ $reasury/
7$ $reasury/
S$ corporate/
7$ corporate/
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The Term !tructure o Interest Rates $erm structure/ the relationshipbet!een interest rates 8or yields9and maturities-
A graph o" the term structure iscalled the yield curve-
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0
10
1
1 10 !0
"ears to #aturity
$nterest
Rate %& 1 yr '.0%
10 yr 11.4%
!0 yr 1!.(%
Real risk-free rate
$nflation )remium
#aturity risk )remium
/ypothetical Treasury 0ield 'urve
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"hat )etermines the !hape o the0ield 'urve&&'pectations about "uture in4ation-
Perceptions about the relativeriskiness o" securities !ith di+erentmaturities-
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The -ure Expectations Theory 1-E/2Shape o" the yield curve depends on the investors1e'pectations about "uture interest rates-
#" interest rates are e'pected to increase. 7($ rates
!ill be higher than S($ rates and vice versa- $hus.the yield curve can slope up or do!n-
P&: assumes that M0P 5 ;-
7ong(term rates are an average o" current and
"uture short(term rates-#" P&: is correct. you can use the yield curve to
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%bserved Treasury Rates
$f +, olds /at does te market e)ect/ill be te interest rate on one-yearsecurities one year from no/ Tree-yearsecurities t/o years from no/
Maturity )ield
> year ?-;@
years ?-@B years ?-@
years ?-D@
D years ?-D@
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'onclusions $bout -E/ Some argue that the P&: isn1t correct.because securities o" di+erent maturities
have di+erent risk-General vie! 8supported by mostevidence9 is that lenders pre"er S($securities. and vie! 7($ securities as
riskier- $hus. investors demand a M0P to getthem to hold 7($ securities 8i-e-. M0P E ;9-
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%ther Factors That Inluence Interest Rate .evels
Federal 0eserve Policy
Federal udget e%cit or Surplus
#nternational Factors
7evel o" usiness Activity
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Trading in Foreign 'urrenciesA spot ratespot rate is the rate applied to buycurrency "or immediate delivery-
Spot &'change 0ate uotationsirect *uotationirect *uotation/ ,-S- dollar price o" one unito" "oreign currency-
#ndirect *uotation#ndirect *uotation/ Foreign currency price
per one unit o" ,-S- dollar-Note that an indirect *uotation is thereciprocalreciprocal o" a direct *uotation-
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Trading in Foreign 'urrenciesA cross ratecross rate is the e'change ratebet!een any t!o currencies not
involving ,-S- dollars-#n practice. cross rates are usuallycalculated "rom direct or indirect ratesHthat is. on the basis o" ,-S- dollar
e'change rates-2hen currencies are not related to oneanother in a consistent manner.currency arbitragecurrency arbitrage opportunities e'ist-
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Trading in Foreign 'urrenciesA "or!ard rate"or!ard rate is the rate applied to buycurrency at some agreed(upon "uture
date-For!ard premium/ F0 E S0
For!ard discount/ F0 I S0
$he primary determinant o" the
spotJ"or!ard rate relationship is relativeinterest rates-
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Interest Rate -arity 1IR-2#nterest rate parity#nterest rate parity implies that investorsshould e'pect to earn the same return on
similar(risk securities in all countries/
:ere.kh 5 periodic interest rate in the home country-
k" 5 periodic interest rate in the "oreign country-
" > 5 one(year "or!ard rate
e; 5 current spot rate
( )( )
h
k
k
e
+
+=
1
1
0
1
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Interest Rate -arity 1IR-2#nterest rate parity sho!s !hy aparticular currency might be at a
"or!ard premium or discount-#" domestic interest rates are higherhigher than"oreign interest rates. the "oreign currencyis selling at a "or!ard premium-
iscounts prevail i" domestic interest ratesare lo!erlo!er than "oreign interest rates-
Arbitrage "orces interest rates back toparity-
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-urchasing -o3er -arity 1---2Purchasing po!er parityPurchasing po!er parity implies thatthe level o" e'change rates adKusts
so that identical goods cost thesame amount in di+erent countries-
PPhh 5 P5 P" " 8Spot rate98Spot rate9 or
Spot rate 5 PSpot rate 5 PhhJPJP" "
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Inlation, Interest Rates, and Exchange RatesLower in4ation leads to lower interest rates. so borro!ing in lo!(
interest countries may appearattractive to multinational %rms-:o!ever. currencies in lo!(in4ationcountries tend to appreciate against those in high(in4ation ratecountries. so the true interest costincreases over the li"e o" the loan-