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FINANCIAL MARKETSThe Level and Structure of Interest RatesChapter OutlineThe Theory of Interest Rates1The Determinants of The Structure of Interest Rates2The Theory of Interest Rates i as anchor:short-term,risk free,real ratevFishers Classical ApproachvLoanable Funds TheoryvThe Liquidity Preference TheoryFishers Classical ApproachAssumption:simplified economyWhy save?Why borrow?Decisions on SavingvMarginal rate of time preferencevIncomevReward for saving(interest rate)Savings/investmentInterest rateSDecisions on BorrowingvGain from investmentvMarginal productivity of capitalvRate of interestSavings/InvestmentInterestrateDEquilibrium in the marketSavings/InvestmentInterestrateDSiSIFishers Classical ApproachvConclusion:long-run level of interest rate and the amount of investment depend onTechnological developmentPropensity to saveSavings/InvestmentInterestrateDSD”iSIiSISavings/InvestmentInterestrateDSiSIiSISFishers LawvReal rate:power to consumevNominal rate:number of monetary unitsvFishers law:inflation&interest rates i=r+p vPower of government,banksvLevel of interest rate is determined byTotal demandHouseholdFirmsGovernmentTotal supplyHouseholdFirmsGovernmentThe Loanable Funds TheoryQuantity ofloanable fundsInterestrateDSvAssumption:wealth in two formsMoneyBondsvBs+Ms=Bd+MdvBs-Bd=Md-MsvDemand for Money BalancesTransactions demandPrecautionary demandSpeculative demandvSupply of MoneyThe Liquidity Preference TheoryEquilibrium in Keyness Market for MoneyThe Liquidity Preference TheoryvShifts in the rate of interestDemand(level of income,level of prices)Supply (actions of central bank)moneyInterestrateMSDiDimoneyInterestrateMSDiiMSChanges in the Money Supplyand Interest RatesvLiquidity Effect If increasing,causes the interest rate to fallvIncome Effect If increasing,causes the interest rate to risevPrice Expectations Effect If increasing,causes the interest rate to risevNet EffectThe Determination of The Structure of Interest RatesvFeatures of a bondvYield on a bondvThe base interest ratevThe risk premiumFeatures of a BondvTerm to maturityvPrincipal value/par value/maturity valuevCoupon rateUnited States,JapanEuropeYield on a BondvYield to maturityCoupon interestAny capital gain or lossExample:a four-year bond with a coupon rate of 5%and a par value of$1,000 is selling for$900.64 Yield:$50 every year+capital gain($99.36)Yield on a BondvTrial-and error processStep 1:select an interest rateStep 2:compute the present value of each cash flow using the interest rate selected in Step 1Step 3:total the present value of the cash flows found in Step 2Step 4:compare the total present value found in Step 3 with the market price of the bond and,if the total present value of the cash flows found in Step 3 isEqual to the market priceGreater than the market price,try a higher interest rateLess than the market price,try a lower oneYield to Maturity of an Annual Pay Four-year Bond with a Coupon Rate of 5%and a Market Price of$900.64Relationship among the coupon rate,market price,and yield to maturityvIf the market price=par valueYield to maturity=coupon ratevIf the market price par valueYield to maturity coupon ratevIf the market price coupon rateSemiannual Payment Securitiesv18-year,coupon rate of 6%,par value of$1,000,pays interest semiannually,is selling for$700.89vC=30,n=36vTrail-and-error:4.75%vAnnualize the semiannual yield:9.5%Interest Rate TriedTotal Present Value3.25%$947.403.50898.543.75853.144.00810.924.25771.614.50735.014.75700.89The Base Interest RatevBenchmarkvTreasury securities,TreasuriesDiscount securitiesCoupon securitiesvBase interest rate=real interest rate+expected rate of inflationOn-the-run Treasury issuesOff-the-run Treasury issuesExample:May 20,2008,the yield for treasuriesTwo-year Treasury 2.34%Five-year Treasury 3.02%10-year Treasury 3.78%30-year Treasury 4.53%The Risk PremiumvTrading at a spread(in basis points)Base interest rate+SpreadBase interest rate+Risk premiumBase interest rate=Real rate of interest+expected rate of inflationvSpreadType of issuerPerceived creditworthiness of issuerTerm to maturityInclusion of optionsTaxability of interestExpected liquidity of an issueTypes of issuervGovernment Market SectorTreasuryMunicipalvCorporate Market SectorUtilitiesIndustrialsFinanceBanksvIntermarket and Intramarket Sector spreadDefault or Credit RiskvRating CompaniesMoodys,S&P,FitchvCredit RatingsInvestment gradeNon-investment gradevCredit Spread5.14%for AAA rated bonds with 10-year maturity,credit spread:136 basis points5.95%for AA rated bonds with 10-year maturity,credit spread:217 basis pointsThe lower the credit rating,the larger the yield spreadvBenchmark interest rateGSECorporate bond with AAAInterest rate sPerceived creditworthiness of issuerExplanationMoodysS&PBest Quality:smallest degree of riskAaaAAAHigh quality:slightly more long-term risk than top ratingAa1AA+Aa2AAAa3AA-Upper medium grade:possible impairment in the futureA1A+A2AA3A-Medium grade:lack outstanding investment characteristicsBaa1BBB+Baa2BBBBaa3BBB-Speculative issues:protection may be very moderateBa1BB+Ba2BBBa3BB-Very speculative:may have small assurance of interest and principal paymentsB1B+B2BB3B-Issues in poor standing:may be in defaultCaaCCCSpeculative in a high degree:with marked shortcomingsCaCCLowest quality:poor prospects of attaining real investment standingCCDTerm to MaturityvMaturity spread/yield curve spreadTwo-year/five-year maturity spread 3.02%-2.34%=68 basis pointsTwo-year/10-year maturity spread 3.78%-2.34%=144 basis pointsvMaturity spread in the corporate bond market:same credit qualityvTerm structure of interest rate:the relationship between the yields on comparable securities but different maturitiesInclusion of OptionsvCall optionvPut optionvConvertible bondvIf the option is favorable to the issuer,the spread is larger than the issue without such an optionvIf the option is favorable to the investor,the spread is smaller than the issue without such an optionTaxability of Interest vAfter-tax yield =pretax yield (1-Marginal tax rate)For example:taxable bond yield of 4%,marginal tax rate of 35%After-tax yield=0.04(1-0.35)=2.6%vEquivalent taxable yield=tax-exempt yield/(1-marginal tax rate)vThe lower the marginal tax rate,the lower the equivalent taxable yieldExpected Liquidity of an IssuevThe greater the liquidity,the lower the yieldvFactor affects the liquidity:size of the issueWhat do you choose?vBank deposits(demand):3.5%vTreasury security:3.85%vCorporate band:5%v嘉实恒生中国企业指数基金,恒生中国企业指数收盘价:6725.58,20100831收盘价:11403,涨幅69.55%vUnited States:Jeremy Siegel 1802-2006,return for stocks:6.8%,return for bonds:2.8%QuestionsvConsider three bonds,all with a par value of$1,000What is the yield to maturity of bond C?Is the yield to maturity of bond A greater than or less than 8%?Is the yield to maturity of bond B greater than or less than 9%?BondCoupon RateMarket PriceA8%$1,100B7 900C9 1,000vConsider the following bond:19 years to maturity,11%coupon rate,pays interest semiannually,$1,000 par value.Suppose that the market price of this bond is$1,233.64.Given the information below,determine the yield to maturity for this bond on a bond-equivalent yield basis.QuestionsInterest Rate TriedTotal Present Value of Cash Flow3.00%$1,562.323.25 1,486.963.50 1,416.823.75 1,351.464.00 1,290.524.25 1,233.64vShow the cash flows for the two bonds below,each of which has a par value of$1,000 and pays interest semiannually:vCalculate the yield to maturity for the two bonds.QuestionsBondCoupon RateYears to MaturityPriceW7%5$884.20Y94 967.70vOn October 19,2007,the yield for three on-the-run issues as reported by Y wastwo-year Treasury 3.90%five-year Treasury 4.14%10-year Treasury 4.49%vCompute all of the maturity spreadsQuestionsvY reported that the yield for corporate bonds with 10 years to maturity on October 19,2007,was 5.39%for AAA rated bonds and 5.66%for AA rated bonds.At the time,the 10-year on-the-run Treasury rate was 4.49%.Compute the two credit spreads.Questions结束语当你尽了自己的最大努力时，失败也是伟大的，所以不要放弃，坚持就是正确的。When You Do Your Best,Failure Is Great,So DonT Give Up,Stick To The End感谢聆听不足之处请大家批评指导Please Criticize And Guide The Shortcomings演讲人：XXXXXX 时 间：XX年XX月XX日
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