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What does a falling yield curve mean?
Interest rstes falling
What does rising yield curves mean?
Interest rates rising
What does steep
Shape of curve mean
There was an expextation of higher interest rates
Term structure of interest rates
Relatinship among yields of om bonds of all different maturities
Curve showing term structure. A b c . Maturiry on x, yield to maturity is y.
Current yeilds. Publiahed rates of interest refkevying observsbke currebt market prices. S sub n
Expected, implied forward rates
I sub n
Formula to invest
- Amount invested x
How are funds to be lent?
Use formula to solve for i2
What happens if higher rate expected for second year?
Sell two yr bonds, paying 11percent on loan. Buy a series of two one year binds earning said valyes. What is the 2 yr rwturn?
Implied rate any year
II sub n =
(1+sN)^n // (1+sN-1). - 1
Firm needs 2 mill from now. How does it borrow at today's interest rates if it does not need these funds for two years, and then only one yer loan. What rate will firm pay on one year loan?
It would sell 1 million in three year bonds. Comp would buy $q1 mill in two year bonds. For the first two years it would pay out interest on two year bond it owns to cover for int on bond it sold. End of second year, bond matures, firm has $1 mill. End of third year it must pay back hilders of three year bond. Determined by i sub n
Interpreting yield curves
Curve reveals a belief in rising or falling rates over period
What determines interest rates
- I sub b= r sub b + wavelength
- Nominal interet rate= observable market rate is a real rate + inflation
Interpreting interest rate formula
If ppl expect inflation to be 5%, and real interest rste is 10, they would buy bonds if interest rate is 15. Bond will not be worth as much tk them cuz it wilk buy 5 less
Yield curves shift
Public is changing views of future. Indiv apparently using other info besidds recent changes in interest rate to predict course of int rates for about ten years in yiekdncueves durng sec and third quarter (flat)
How could firm borrow 2 million three years from now for two years by buying and selling bonds in current period.
Sell $2 mill in 4 yr bond. Buy $2 mill in 3 yr bond. First three years pay out interest, matures, get money
What is implied forward rate during 4 year with a three yield bond at 7% and four year bond at 8?
I sub n equation
Fed Reserve system
- central bank of U.S. direct control of monetary base, regulatory powers over many depository institutions,; HQ in DC=> BOG; associated with it are 12 regional Fed Res Banks and their 25 branches throughout U.S; comptroller of currency regulates commercial banks that have a federal charter and are called national banks. BOG sets max interest rates on deposits.
- small group of 12 people members of Federal Open Market Committee has primary responsibility for controlling money supply.
- Board has final word on all major decisions except for those pertaning to money supply through open market ops.
7 members, appointed by Pres of US. chairman and vice included. serve on FOMC too.
- 7 members of BOG + 5 reps of regional banks (NY one is always included).
- one of most powerful economic policy groups in gov
- formulates Fed Res' open market policy
how are fed banks organized? what are member banks? what is the difference b/w the two?
each of 12 fed res banks organized as a separate corporation, which must be distinguished from private commercial, which may or may not be member banks. member banks are member of fed res. national banks must join. state optional. private commerical maybe.
Fed banks' board of directors and constituency
directors of each reserve bank classified into three groups. 3 members/group. A B C
- Pres and VP appointed by BOG from class C
- CLass A & B elected by member banks.
Fed bank presidents
selected by boards of directors individual banks
banks clear b/w themselves, done electronically. clear across country. fed does 30-40% of them. digital transfer. just on a computer. bank float. take from account and another. bank on which it is drawn, can invest it and make interest on it until it clears. bank that deposited in also make interest.
monetary policy & tools
supply of money. interest rates. inflation. level of economic activity. international exchange value of dollar.
- 3 ways of affecting monetary supply:
- 1. open market operations
- 2. loans to depository institutions (discounts and advances)
- 3. reserve requirement changes
effects of open market operations and loans
invovle the purchase or sale of debt instruments which causes the monetary base to to increase or decrease, respectively
- open market: bonds to public sector
- loans: granting and retiring loans
effects of reserve req changes
- affects amount of money that depository institutions can creater per dollar of reserves.
- do not change monetary base.
- the lower the reserve req, the more than can be invested in income-earning assets.
lower reserves expands money supply. increasing reserves decresase money supply.
- interest rate charged by reserve bank to depository institution.
- announcement effect: an effect of major changes in discount rates (i.e. fluctuations in stock market prices).
- Fed res cannot directly raise market interest rates. can change monetary base and influence thereby.
12 fed res banks supervises and examines state member banks in its district. bank examiners sent out fed banks. all bank holding comps regulated by fed res, whcih must pass on all mergers and acquisitions.
agent fo us treasury auction
fed reserve banks serve as fiscal agents by conduction the treasury's sale of treasury obligations.
currency and coin custodial services
- Fed responsiblity of supervising and maintaining quantity of currency. when purchase made in store, deposited into depository institution. depository institution deposits most of currency at regional fed reserve bank or its branch. expert handlers check for counterfeited, worn out, mutilitaled ones.
- ACH, EFT: clears funds w/o paper checks. Fed res largest supplier of these services
does congress have control over money supply?
cannot literally appropriate money. can only vote on expenditures.
- specific credit regulations
- regulates payment of interest on bank deposits
- control over margin reqs for loans to purchase stocks
- payments mechanism functions: provision of coin and curency, check-clearing services, wire transfers, automated clearinhouses,
bank vs financial holding compnies
- bank holding comp are corps that own more than one banks
- financial holding comp are comp that not only banks but also own all sorts of financial companies. have to be approved by fed reserve. can own insurance and brokerage com pans.
what does a bank buy in money markets? instruments they buy
- 1. U.S. Treasury Bills
- 2. Federal agency securities
- 3. CD
- 4. Banker's acceptances.
- 5. Commercial paper
- 6. Federal Funds
- 7. Repurchase agreements
what are money markets?
a group of markets in which low default risk, very liquid, large-denomination debt instruments are traded
how are interest rates managed by Fed>
The Federal Reserve uses open market operations to influence the supply of money in the U.S. economy to make the federal funds effective rate follow the federal funds target rate. Cannot directly raise interest rate, can change monetary base to influence interest rates.
how, why, and under what authority does Fed appropriate loans to foreign countries bypassing the Congress?
what is a commercial bank? how do they make $$?
type of financial institution and intermediary. must take deposits and loan money. money created through borrowing and lending.
purpose of stock market?
- symptom or reaction to economy
- huge amount of wealth held in form of stocks
- changes in value of wealth can affect spending and investment
- can lead to recession
money aggregates; monetary base
- M1= CC + D
- M2= M1 + Money market funds + consumer time deposits
relates to money supply
inside and outside money
- inside money: money produced by fed
- outside money: by banking system
takes money in one form and transfer to another form of financial asset.
- composed of currency and coin outside of deposit institutions plus reserves of deposit institution
- only part of money supply, not complete.