...A financial market is a market in which people and entities can trade financial securities, commodities, and other fungible items of value at low transaction costs and at prices that reflect supply and demand. Securities include stocks and bonds, and commodities include precious metals or agricultural goods. The definition may be termed as: "Financial Markets are generally known as a market where financial securities or/and assets are bought and sold by the buyers and sellers respectively." Some of the salient features of financial market are: • Transparent pricing • Basic regulations on trading • Low transaction costs • Market determined prices of traded securities Basic Functions of Financial Market: Financial market has emerged as one of the biggest markets in the world. It is engaged in a wide range of activities that cater to a large group of people with diverse needs. Six key functions of Financial Market are – 1. Borrowing & Lending: Financial market transfers fund from one economic agent (saver/lender) to another (borrower) for the purpose of either consumption or investment. 2. Determination of Prices: Prices of the new assets as well as the existing stocks of financial assets are set in financial markets. 3. Assimilation and Co-ordination of Information: It gathers and co-ordinates information regarding the value of financial assets and flow of funds in the economy. 4. Liquidity: The asset holders can sell or liquidate their assets in financial market...
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...1. What is the Treasury yield curve and what does it represent? The yield curve is one way to look at interest rates. It shows the relationship between the rates or yields being offered by bonds of different maturities. It is usually based on U.S. Treasury Bonds. It is mainly used as a benchmark for other debt in the market, such as mortgage rates and bank lending rates. Investors also use the yield curve as a reference point for forecasting interest rates, pricing bonds and creating strategies for boosting total returns. It is also a reliable leading indicator of economic activity. 2. Explain the difference between current yield and yield-to-maturity (YTM). Current Yield: it is the annual return earned on the price paid for a bond. It is calculated by dividing the bond’s annual coupon interest payment by its purchase price. Yield-to-maturity: it is the total return an investor will receive if the bond or the security is held until the maturity date. It reflects the total return to the bond holder of holding the bond until maturity which includes which includes all the interest payments from the time of purchase until maturity including interest on interest, it also includes any appreciation or depreciation in the price of the bond. 3. Explain the difference between the coupon rate and the YTM. Coupon rate: it is the amount of interest paid every year on a bond. It is expressed as a percentage of the face value of the bond. It determines the income that will...
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...I was trading in a risk free market called Treasury bill and Treasury bond. They are called risk-free because the government backs them up. Due to the fact that the government is never expected to back from its credits, the security is labelled risk free. In this trading, there were 3 tradable securities, 2 risk free Treasury bill and 1 Treasury bond. I was given an endowment of $1,000,000 dollars at the starting and I could buy long and sell short. Total time of the trade was 5 minutes (312 seconds). First Treasury bill (TB6M) expires in 6 months and the second one (TB12M) expires in 1 year. A 6-month period time was 312 seconds (5 min) which equals to 1 period. The strategy I applied in the beginning of the first period was similar to that of liquidity traders, in which I was actively trading the TB6M Treasury bill continuously at limit orders to cause price fluctuations. The reason I was focusing on the 6 month Treasury bill was because at the end of the first period, they close out for $100 dollars. I was actively trading it on limit orders to cause price fluctuations which allowed me to get close to mid-market prices. Near the end of the 1st period, I purchased them to my full capacity of my margin loan. Since I was actively trading I missed out on the risk free interest which was compounded on cash and it was paid weekly (12 seconds), for the first period it was 7% (weekly rate 0.1302%) percent and then for second period it changed to 9%(weekly rate 0.1659%). At the end...
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...Bond Markets A bond is a debt security, or basically a loan, that an investor makes to a corporation, a government, an agency, or municipalities. In return for up-front cash, a corporation or government promises to make specific payments to a bondholder on specific dates. The bondholder can not only expect fixed payments but also the principle repayment when the bond reaches its maturity date (The Bond Market, 2002). A bond is considered a fixed-income security because the investor knows the exact amount of cash that will be paid back if the bond is held until maturity. A bond market is a financial marketplace where investors can purchase and sell various types of bonds or debt securities. It can be categorized into three main groups: issuers, underwriters, and purchasers. Issuers sell bonds or other debt securities in the bond market to finance the operations of their various organizations. The main issuers of the market are governments, banks, and corporations. Underwriters are traditionally made up of investment banks and other financial institutions that help the issuer to sell the bonds in the market. The need for underwriters is the greatest for corporation debt market because there are more risks involved. Purchasers are made up of those who buy the debt being issued in the market. They can include not only every group mentioned but also any other type of investor, including the individual. The largest player in the market is governments because they borrow and lend...
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...institutions (2) Loanable funds theory (3) In‡ ation, nominal interest, and real interest rate (4) Bond valuation (5) Yield (6) Yield curve Corresponding book chapters: Chapter 1 and 2. 1 1.1 Main function performed by …nancial institutions There are many types of …nancial institutions: commercial banks, investment banks, pension funds, mutual funds, hedge funds, credit rating agencies, etc. Financial institutions facilitate funds transfer from suppliers to users. In some transactions, there is no need for a …nancial institution. In the following example, a small company borrows directly from the owner’ friends. s 2 In other transactions, a …nancial institution is useful or even necessary. In the following example, the credit rating agency (Moody’ indirectly participates in funds transfer. s) 3 In the following example, the bank directly participates in funds transfer. Several questions naturally arise: (1) How do banks make money? (2) Why don’ companies borrow directly from households? t (3) What risks do banks face? (4) How do banks manage these risks? These are the main questions that we will study in this course. 4 1.2 Loanable funds theory Interest rate is the cost of borrowing or the price paid for the rental of funds. There are many interest rates in the economy, such as interest rates on mortgages, auto loans, corporate bonds, and government bonds. Because di¤erent interest rates have a tendency to move in tandem, people often talk about...
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...Quantitative easing (QE) is an unconventional monetary policy tool used by some central banks to stimulate the national economy when conventional monetary policy has become ineffective. In the late 2008 Federal Reserve pursued this unconventional policy of purchasing large quantities of long-term securities, including Treasuries, Agency bonds, and Agency Mortgage Backed Securities. The stated objective of quantitative easing is to reduce long-term interest rates in order to spur economic activity. A central bank implements quantitative easing by purchasing financial assets from banks and other private sector businesses with new money that is created electronically. This action increases the excess reserves of the banks, and also raises the prices of the financial assets bought, which further lowers their yield. The recent quantitative easing policy targeted at credit easing in the business and household sector, so that the increase in reserves is a by-product rather than an objective of monetary policy. As a part of its expansionary monetary policy the Fed has maintained a lower short-term market interest rate through the buying of short-term government bonds, using a combination of lending facilities and open market operations. However, with the housing bubble reaching the sky, consumer spending and consumer confidence has been quite low and also with short-term interest rates at, or close to zero, normal monetary policy has lost its ability to impact the market demand that...
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...Bond Prices, Default Probabilities and Risk Premiums1 John Hull, Mirela Predescu, and Alan White A feature of credit markets is the large difference between probabilities of default calculated from historical data and probabilities of default implied from bond prices (or from credit default swaps). Consider, for example, a seven-year A-rated bond. As we will see the average probability of default backed out from the bond’s price is almost ten times as great as that calculated from historical data. Why are the two estimates of the probability of default so different? The answer is that bond traders do not base their prices for bonds only on the actuarial probability of default. They build in an extra return to compensate for the risks they are bearing. The default probabilities calculated from historical data are referred to as real-world (or physical) default probabilities; those backed out from bond prices are known as risk-neutral default probabilities. Real-world default probabilities are usually less than risk-neutral default probabilities. This means that bond traders earn more than the risk-free rate on average from holding corporate bonds. Risk-neutral default probabilities are used when credit dependent instruments are valued. Real-world default probabilities are used in scenario analysis and in the calculation of bank capital under Basel II. Altman (1989) was one of the first researchers to comment on the discrepancy between bond prices and historical default data. He...
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...related to its degree of financial sector development. Developed countries’ experience suggests that strong government bond market creates favorable environment for the development of an efficient corporate bond market although it is not always essential for a country to develop a government securities market. The financial markets, pivotal point of financial sector, execute a crucial role within the global economic system such as attracting and allocating savings, setting interest rate and discovering the prices of financial assets (Rose, 2003). A well diversified financial sector is highly dependent on the extreme collaboration of financing from equity market, bond market, and banks. The government bond market forms the backbone of a modern securities market in both developed and developing countries. Bangladesh has not been blessed with the contribution of both Corporate and Government bonds and consequently experiences the poor economic growth. With the current financial structure, characterizing the dominating presence of commercial banks, particularly the State Owned Commercial Banks (SCBs), the debt market of Bangladesh is very small relative to other South Asian countries amounting only 5.5 percent of country’s GDP (Mujeri and Rahman 2008). It is in the light of above perspective; this report seeks to explore some prerequisites to a sustainable bond market by studying available literature, especially for the Government segment, and putting some instructions for the...
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... Essay Questions Midterm #2 1. “A government whose bonds are widely held by the general public is less likely to face violent revolution.” Why might that be the case? Before we answer the first question, we must need to know what a “Government Bond” is. It is a debt security issued by a government to support government spending, most often issued in the country's domestic currency. Federal government bonds in the United States include: the savings bond, Treasury bond, Treasury inflation-protected securities (TIPS), and others. In my opinion, there are three main reasons for this question. Firstly, before investing in government bonds, all of investors need to assess several risks associated with the country such as: country risk, political risk, inflation risk, and interest rate risk. For example, if Americans don't have enough faith and credits to Federal government, they won't buy the Treasuries, debt securities issued by the Department of the Treasury on behalf of it. If the government fund was widely hold by the general public, it means they have faith to the government and they consider it as the safest and most popular choice of investments. And they won't against government with violence. Supposed that if the people overturned the government, they won't get their money that was borrowed by it back. So they usually won't do that. Secondly, the government bond which was widely hold plays a positive and important role in boosting...
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...Economics 303 Money and Banking Final Exam Spring Quarter 2014 Prof. Giorgio Canarella PART 1. Problem on M1 Money Supply Determination. Show your work. Use a bluebook Assume that on January 1 2013 the Federal Reserve has determined that following parameters characterize the US economy: a) C/D = 0.2 b) ER/D = 0.3 These ratios have been defined in class and are assumed constant. c) MB = USD 12000000 d) Required reserve ratio on checkable deposits = 0.10. Find: 1) the M1 money multiplier 2) the M1 money supply 3) total reserves 4) required reserves 5) excess reserves 6) currency 7) demand deposits. On June 1 2013 the Federal Reserve increases the monetary base by USD 1000000. Find: 1) the new M1 money multiplier 2) the new monetary base 3) the new M1 money supply 4) the new total reserves 5) the new required reserves 6) the new excess reserves 7) the new currency 8) the new demand deposits. On October 1 2013 the Federal Reserve reduces the required reserve ratio on checkable deposits by 5%. Find: 1) the new M1 money multiplier 2) the new monetary base 3) the new M1 money supply 4) the new total reserves 5) the new required reserves 6) the new excess reserves 7) the new currency 8) the new demand deposits On January 8 2014 the Federal Reserve increases the required reserve ratio on checkable deposits by 15% and increases the monetary base by USD 2000000. Find: 1) the new M1 money multiplier 2) the new monetary base ...
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...[pic] |59% (17 out of 29 correct) |Responses to questions are indicated by the [pic]symbol. | | | | |[pic] |1. |The stockholders of a corporation have unlimited liability. | | | | | | | |[pic]A. | | | |True | | | | | | | | | | | |[pic]B. | | | |False | | | | ...
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...for a summer research grant. The usual disclaimer applies. Are TIPS the “Real” Deal?: A Conditional Assessment of their Role in a Nominal Portfolio Abstract This paper documents predictable time-variation in the real return beta of U.S. Treasury inflation protected securities (TIPS) and in the Sharpe ratios of both indexed and conventional bonds. The conditional mean and volatility of both bonds and their conditional correlation are first estimated from predetermined variables. These estimates are then used to compute conditional real return betas and Sharpe ratios. The time-variation in real return betas and the correlation between TIPS and nominal bonds coincides with major developments in the fixed income market. One implication of this predictability is that portfolio managers can assess more efficiently the risk of investing in TIPS versus conventional bonds. Conditional Sharpe ratios indicate that over the sample period, TIPS had superior volatility-adjusted returns relative to nominal bonds. This finding is striking in view of the absence of a major inflation scare during the sample period from February 1997 through August 2001, but is loosely consistent with the possibility that TIPS elevated rather than reduced Treasury borrowing costs. On the other hand, mean-variance spanning tests...
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...AB Bank – PD General Information: Initiative by Bangladesh Bank to develop a vibrant secondary market of government securities in Bangladesh. Initially there were 12 banks and 3 NBFI’s who became PD’s, but later on when the market wasn’t successful the NBFI’s took permission from the central bank and left the market. Initial Advantage: * Only PD can attend the auction (no one else) – this allowed them to buy the securities accordingly and then sell to other non-PD bodies. Scenario * After some time AB Bank’s saw that the supply of government securities was more than the demand. The treasury bills and bonds were not attractive to the market. * Banks were exhausted with government securities and had more than required * Due to poor market demand, the banks were stuck with the government securities. * In 2013, the market was opened to everyone, meaning that non-PD banks, corporate bodies, and individuals can bid for government securities. * However the non-PD bids were to be placed through a PD. (Details described in the mechanism) * Meaning that before non-PDs had to BUY the securities from the PDs, but now they bid for securities through the PD. The PD acts like an intermediary. Requirement Mechanism * Each PD fixes the amount and rate of government securities according to their need. * Usually this percentage is fixed based on total demand and liability. * But sometimes there is also called “devolvement” * Devolvement: PD’s...
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...Chapter 5 The Financial Environment: Markets, Institutions, and Interest Rates ANSWERS TO END-OF-CHAPTER QUESTIONS 5-1 a. A money market is a financial market for debt securities with maturities of less than one year (short-term). The New York money market is the world’s largest. Capital markets are the financial markets for long-term debt and corporate stocks. The New York Stock Exchange is an example of a capital market. b. Primary markets are the markets in which newly issued securities are sold for the first time. Secondary markets are where securities are resold after initial issue in the primary market. The New York Stock Exchange is a secondary market. c. In private markets, transactions are worked out directly between two parties and structured in any manner that appeals to them. Bank loans and private placements of debt with insurance companies are examples of private market transactions. In public markets, standardized contracts are traded on organized exchanges. Securities that are issued in public markets, such as common stock and corporate bonds, are ultimately held by a large number of individuals. Private market securities are more tailor-made but less liquid, whereas public market securities are more liquid but subject to greater standardization. d. Derivatives are claims whose value depends on what happens to the value of some other asset. Futures and options are two important types of derivatives...
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...Money is a unit of account Money avoids the need for a double coincidence of wants. Money counters the effects of Gresham’s Law. 2. Suppose the Fed looks to make an open market sale to the banking sector of $1 million worth of securities. If you were to trace the effects of this through the T-accounts for the Fed, the banking sector as a whole and the general public, which of the following would you observe? (a) (b) (c) (d) Bank reserves held at the Fed would increase by $1m. Bank reserves held at the Fed would decrease by more than $1m. Money supply would fall by more than $1m. Bank deposits would increase by more than $1m. 3. Amy is considering buying a nominally denominated coupon bond at the prevailing price, P. Which of the following will increase expected real returns on the bond over the next year, if other things are held constant? (a) (b) (c) (d) Higher inflation expectations for the year. Higher expectations for future interest rates. Lower...
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