# Inflation and Yield Curve

**Topics:**Inflation, Capital asset pricing model, Monetary policy

**Pages:**5 (755 words)

**Published:**May 2, 2013

Exam Review:

GDP:

* Y = C + I + G + ( X - M )

Pent-Up Demand

“If you want to slow an economy to a screeching halt, make tax policy uncertain.”

Fiscal Cliff:

* Jan 1, 2013

* Bush era tax cuts expire, increasing tax rate for ALL income groups * Automatic spending cuts

(Official) Start of the last recession:

* December 2007

(Official) End of last recession:

* June 2009

Chapter 16:

* Not on final, but know the difference between risk of bankruptcy and direct costs of bankrupty * During liquidation, bond holders and equity holders at serious odds. Equity holders want to take massive risks to try and save firm because they have no skin left in the game.

Chapter 17:

* Only standard DCF (like from midterm)

* will not be tested on

Why can IRR be misleading?

* Multiple IRRs

* Timing problem

* Scale problem

When do we prefer preferred over common stock?

* Bankruptcy

* Dividends

Agency Costs:

* Example: stockholders vs bond-holders during bankruptcy * Agent acts in interest of Principal

* Costs:

* Misaligned interests

* Observation costs

* When interests misaligned, how can you resolve?

* Proxy-fight: takeover of governance by electing new BOD

Treasury Bonds, Notes, Bills:

* Bond: 10 years or more

* Note: 1 - 10 years

* Bill: less than 1 year

* Are they risk free?

* Yes: US gov’t has largest army and will take stuff to pay its bills * No: Interest rate risk, and Inflation Risk

* Overall: not risk free, but are default risk free

Need to value a bond:

1. Coupon

1. Annuity, fixed for some period of time

1. Principal

Will ask to value separately

* If interest rates increase, value of bond decreases

* If interest rate returns to original rate, bond value returns to $1000

Will give information about stock, asked to calculate company’s required return: * For example, given price

* Given PE ratio

* Given dividends

* Given growth rate

* Given return on Sales, Assets, or Equity

Will have to calculate a plow-back

Will need to calculate the weighted average cost of capital (WACC): * Weight of stock * Required Return of Stock + Wdebt*Rdebt*(1-Tc)

Financial Markets

* Dealer markets vs broker markets

* Dealers own the asset, brokers don’t own the asset

One calculation taking a P&L statement and figuring out the present value of an investment: * Exactly like bowling ball company example

Estimate an IRR:

* Given NPV and discount rate, can estimate IRR

* If NPV = 0, and DR = 10, IRR = 0

* If NPV > 0, DR = 10, IRR > 10

* If NPV < 0, DR = 10, IRR < 10

Given list of costs, define them:

* Sunk costs ← ignore

* Opportunity costs ← do care about

* opposite of sunk costs

Current Events:

* Federal Reserve

* Yield Curve (NOW)

* 30 day → .16% rate

* 30 year → 2.79% rate

* Rise = 2.63%

* Yield Curve (Jan. 1, 2007)

* 30 day → 4.79%

* 30 year → 4.79%

* Rise = 0 ← FLAT

* Yield Curve (Jan. 16 2007)

* 30 day → 5.00%

* 30 year → 4.85%

* Rise = -.15% ← INVERTED!!! Definition of credit crunch * Tools:

* Fed Funds Intended Rate

* 0 - 0.25% currently

* 2 goals:

* Low unemployment

* Low inflation (stable prices)

Capital Asset Pricing Model:

Ri = Rf + Bi(Rm - Rf)

* How do you measure an assets systematic risk?

* Beta!

Characteristic Returns by Asset Class:

* Dow is a Dozen!

* Private Equity → 24% (all nominal rates)

* Small Cap → 18%

* Large Cap → 12%

* Long-term Corporate & Gov’t Bonds → 6%

* T-Bills (Risk free Rate) → 4%

* Inflation Rate → 3%

Inflation: CPI

* August: 0.6%

* September: 0.6%

* October: 0.1%...

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