1 interest rate fluctuations chapters 5. learning objectives understand why bond prices and interest...
Post on 22-Dec-2015
230 Views
Preview:
TRANSCRIPT
Learning Objectives
• Understand why bond prices and interest rates move in the opposite direction
• Describe the structure of TIPS
• Use supply and demand analysis to explain the effect of various events on the interest rate
• Use supply and demand analysis to explain the Fisher effect.
2
4
TIPS (Treasury Inflation Protection Securities)
• Originally issued in 1997.
• Interest and principal payments are adjusted for inflation.
• In times of high inflation the $ amount paid to investors rises.
• Return on TIPS relative to regular Treasurys provides information on expected inflation.
Supply and Demand of Bonds
Supply: borrowers (issuers of bonds)
Demand: lenders (buyers of bonds)
10
15
Shift Factors for the Demand for Bonds
• Wealth
• Expected return
• Expected interest rate
• Inflationary expections
• Relative Risk
• Relative Liquidity
17
1. Profitability of Investment Opportunities
Business cycle expansion, investment opportunities , Bs , Bs shifts out to right
2.Expected Inflation
e , Bs , Bs shifts out to right
3.Government Activities
Deficits , Bs , Bs shifts out to right
Shift Factors for Supply of Bonds
19
Changes in e: the Fisher Effect
If e 1. Bd shifts in to
left2. Bs , Bs shifts
out to right3. P , i
© 2005 Pearson Education Canada Inc.
20
• What will happen to bond prices if stock trading commissions decrease? Why?
• What will happen to bond prices if bond trading commissions increase? Why?
• What will happen to bond prices if the government implements tax increases? Why?
21
• If government revenues drop significantly (and remember all else stays the same, including government expenditures), what will likely happen to bond prices? Why?
• If the government guaranteed the payment of bonds, what would happen to their prices? Why?
• What will happen to bond prices if the government implements regulatory reforms that reduce regulatory costs for businesses? Why?
• If government revenues increase significantly, what will likely happen to bond prices? Why?
• What will happen to bond prices if terrorism ended and the world’s nations unilaterally disarmed and adopted free trade policies? Why?
• What will happen to bond prices if world peace brought substantially lower government budget deficits?
22
Changes in the money supply
Two effects:
The initial effect of more money to invest lowers the interest rate, but if market participants expect inflation then the Fisher effect will cause the interest rate to increase.
23
top related