Effects of Interest Rates on Price of Securities

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Yield (total return) = Dollar inc + (end-beg)
beg. Value
Risk of Return = r= Risk Free rate + Risk Prem
Risk Free Rate = rRF = r* + IP
-effects of int rates on PV/Price of securities: int goes up, value of bonds goes down, stock goes down (NPV) Prices -factors that influence int rates/yield curve
1.production opportunities-return avail w/in an economy from inves. In productive asset; higher prod opp, higher return 2. Time preferences for consumption
3. Risk-change that fin asset won’t earn return promised
4. Inflation-price goes up over time
5. Federal reserve (monetary policy)-slow(control)growth and int rates go up; loosens money supply, int goes down (easy fed policy) 6. Deficit (fiscal policy)s- gov’t borrows, int goes up; larger the deficit, the higher the int 7. Int’l business-trade deficit goes up, int rates go up

8. Business activity-goes up, int goes up
-nom risk free rate-rate of int on sec that is free of all risk (Tbil) -real risk free ratio-int rate that would exist on risk free sec if inflation is expected to be 0 during invest. Pd -inflation prem-prem for expected inflation that investors add to real-risk free rate of return -default risk prem-diff btwn 1 int rate on a US T-bond & corp bond of = maturity&marketability; wont meet obligations -maturity prem-longer maturity, higher risk

-term structure of int rates-relationship btwn LT&ST rates -yield curve-relationship btwn LT/ST rates
-normal yield curve=LT higher than ST rates; upward
-expectations theory-shape of yield curve depends on expectations concerning future inflation rates -mkt segm theory-every borrower&lender has a preferred maturity&slope of yield curve depends on supply of dem for funds in LT mkt relative to ST mkt -open mkt ops-fed reserve buys/sells treasury sec to expand/contract US money supply Ch. 6 Bond Valuation

-bond-LT contract under which borrower agrees to make payments of int and principal on specific dates to bondholder -coupon rate – total int paid each year, stated as % of bond’s face value -bond trade @ discount-required rate of return is HIGHER than coupon rate -bond trade @ prem – rate of return is LOWER than coupon rate -when mkt value of debt is the same as its face value, it’s sold at par value -bond ratings-based on qualitative&quantitative factors; fin strength, collateral provisions, seniority of debt, restrictive covenants, etc - AAA & AA are extremely safe

-invest. Grade bonds-lowest rated bonds that many banks and other institutional investors may hold by law -bond’s ratings is an indicator of all its default risk; most are purchased by institutional investors who are legally restricted to investments -changes in ratings affect firm’s ability to borrow LT capital and cost of that capital -types of debt: short term

1. Treasury bills-issued by gov’t to finance its operations & programs 2. Repurchase agreements-firm sells some of its fin. Assets to another firm w/ a promise to repurchase the security @ later date 3. Federal funds-overnight loans from one bank to another

4. Banker’s acceptance-issued by a bank that obligates the bank to pay a specified amt @ some future date 5. Commercial paper-discounted instrument that is a type of promissory note; “legal” IOU 6. Cert. of Deposits (CDs)-int earning time deposit @ a bank or other fin intermediary trad-issuing company, specified time pd

negotiable-traded to other investors, can be redeemed whenever 7. Eurodollar deposit-deposit in a bank outside the US that is not converted into currency of foreign country 8. Money market mutual funds-pools of funds managed by invest. Companies that are primarily invested in ST fin assets LONG TERM DEBT

1. Term Loans-obtained from bank or insurance company, borrower agrees to make series of payments consisting of int + principal 2. Bonds-LT contract under which borrower agrees to make payments of int + principal on specific dates to...
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