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Economics 434

Economics 434. Financial Markets Professor Burton University of Virginia Fall 2011. Two Pillars of Capital Markets. 1. Debt. 2. Equity. Debt. Has a fixed return (categorized by Issuer): Government: sovereign, municipal Corporate: public & private Individual: (mortgages, cc’s).

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Economics 434

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  1. Economics 434 Financial Markets Professor Burton University of Virginia Fall 2011

  2. Two Pillars of Capital Markets 1. Debt 2. Equity

  3. Debt • Has a fixed return (categorized by • Issuer): • Government: sovereign, • municipal • Corporate: public & private • Individual: (mortgages, cc’s)

  4. Sovereign Debt is Government Debt • Two possibilities • They can print their own currency • USA • Switzerland • Japan • China • They are part of a larger currency union • France, Germany • Greece, Spain, Italy • California, Virginia (this is usually called “municipal” debt)

  5. Assume you can print your own currency • A “technical default” would only occur by choice, since any obligation can be satisfied by printing money • But value of future payments may be very uncertain (think inflation) • This could be a default as well because, effectively, the borrower pays back less value than was received from the lender

  6. The concept of “default free security” • This means that the security honors its promises (it does not mean the security is riskless) • If it says it will pay you $ X, then it will pay you $ X exactly as promised • But, what is $ X worth at time of payment?

  7. Example of “default free security” • Sovereign debt (debt issued by government) • In the US • Treasury bills (issued with less than one year of maturity) • Treasury notes (issued with more than one year of maturity but less than ten years of maturity) • Treasury bonds (issued with ten or more years of maturity)

  8. US Treasury Debtas of 7/31/11 • $ 9,755,796,000,000 ($ 9.7 Trillion) • Made up of: • $ 1.5 Trillion in bills • $ 6.2 Trillion in notes • $ 1 Trillion in bonds • The rest US savings bonds and things like that • Intergovernmental holdings $ 4.5 Trillion • Total debt is $ 9.75 plus $ 4.58 equals $ 14.3

  9. Who Owns US Debt? • $ 4.47 owned by non-US • The rest, one way or another, is owned domestically

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