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【正文】 Bo nds M ov e T o get her31 C) Liquidity Premium Theory The theory that investors demand a risk premium on long–term bonds. The risk premium required to hold longer term bonds is called liquidity premium Investors and firms are willing to hold these bonds. Why? A: Yield curve will be upward sloping even in the absence of any expectations of future increases in rates. If the liquidity preference theory is valid, the forward rate of interest is not a good estimate of market expectations of future interest rates. Why? A: 32 Pure Expectations Theory Yield Curve Liquidity Premium Theory Yield Curve Interest Rate Years to Maturity Relationship between the Expectations Theory and the Liquidity Premium Theory Liquidity Premium 5 10 15 20 25 30 0 33 What theory explains better the TSIR? The Liquidity premium theory explains better the empirical facts such as 1. That interest rates on different maturity bonds move together over time. 2. That yield curves tend to be upward sloping when shortterm interest rates are low and to be inverted when shortterm interest rates are high. 3. It explains that yield curves typically slope upward by recognizing that the liquidity premium rises with a bond’s maturity (because of investors’ preferences for shortterm bonds). 34 In summary The liquidity premium theory predicts the behaviour of future short term interest rates by looking at the slope of the yield curve: 1. A steeply rising yield curve indicates that ST i’s are expected to rise in the future 2. A moderately rising yield curve indicates that ST i’s are not expected to rise or fall much in the future. 3. A flat yield curve, indicates that ST i’s are expected to fall moderately in the future. 4. An inverted yield curve, indicates that ST i’s are expected to fall sharply in the future. 35 Yield curves and the market’s expectations of Future ShortTerm Interest Rates YTM Term to Maturity a) Short term interest rates expected to rise YTM Term to Maturity b) Short term interest rates expected to stay the same (. the YTM used is considered constant for each period in the putation of NPV projects) YTM Term to Maturity c) Short term interest rates expected to fall moderately YTM Term to Maturity d) Short term interest rates expected to fall sharply 36 6. Predictive Power of the yield curve Future interest rates Does the slope of the yield curve provides a reliable forecast of future i’s? A: Recent research shows that the TSIR provides information for the very short run, over the next several months, and the long run, over several years. It provides unreliable forecast in interest rates over the intermediate term, the time in between 37 Recessions, economy recoveries (and inflation) (based on a study by A. Estrella and F. Mishkin (1996), FRBY) If 10year Government bond rate is % above 3month Tbill rate ? Probability of recession one year ahead is 5%. (Upwardsloping or Downwardsloping yield curve?) Better investment strategy: stocks, short term Tbills,or LT bonds? Assume the difference in yields is 4% (which is very high for historical standards). * What would you expect to happen to the yield curve? * What type of security would you invest (disinvest)? If 10year Government bond rate is % below the 3month Tbill rate ? Probability of recession one year ahead is about 90%. (Upwardsloping or Downwardsloping yield curve? 38 7. Conclusions The Interest rate (i) is usually determined by the interaction of the demand and supply of loanable loans. Various factors affect the direction of i Central banks intervene regularly on the direction of interest rates to achieve its goals. Changes in i have impact on the value of financial claims that may result in large losses (for investors and/or firms) ? Interest Rates are carefully monitored on a daily and intraday basis TSIR is an important forecasting tool of the direction of interest rates along with scheduled press announcements by Central Banks
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