Global Financial Markets.5-27.St

8/18/2019 Global Financial Markets.5-27.St

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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-

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Global Financial Markets.5-27.St

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