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Macroeconomic Analysis

Macroeconomic Analysis. Financial Market and Expectations. Contents. Financial system and its importance in the Economy Determination of Instalment payments Growth of funds and their present values Fisher Equation: Real and nominal interest rates

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Macroeconomic Analysis

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  1. Macroeconomic Analysis Financial Market and Expectations Lecture 10

  2. Contents • Financial system and its importance in the Economy • Determination of Instalment payments • Growth of funds and their present values • Fisher Equation: Real and nominal interest rates • Bond market: Value of bonds and yield to maturity • Arbitrage condition • Stock market: value of stocks by the interest rate, risk premium and growth of dividends • Investment decision problem • Impact of changes in the interest rate in the price of assets Lecture 10

  3. Link Between Financial System and the Economy Y= F(K,L) C T S Funds K FA Deposit Banks Pension Funds Treasury Bonds Profit Equity Lecture 10

  4. Major Players in a Financial Market Savers Households, Corporations and Government G O V E R N M E N T & F S A C E N T R A L B A N K http://www.fsa.co.uk http://www.dmo.gov.uk/ Intermediaries Banks, Insurance Companies, Building Societies, Trusts, Stock and Bonk Markets Investors Small, Medium and Large Private, Public, Domestic and Foreign CATS Lecture 10 http://www.londonstockexchange.com/default.asp

  5. Financing of an Investment Project Need for Capital Demand for output Financing an Investment Project Self Finance Bequests Bonds: Debt Finance Banks, Building Society, Insurance Equity Finance Stock Market (LSE) Maturity Instalment Method Repayment Method No Risk Risk High Risk Lecture 10

  6. Calculations of Instalments on a Loan: Lower Interest Rate Reduces the Interest Payment Lecture 10

  7. Numerical Example for the Instalment Calculations Lecture 10

  8. Calculation of Instalment Payment on 20000 at 8.9 APR at 12 Instalments (from the spreadsheet) D =20000 i = 8.9 APR Lecture 10

  9. Calculations of Instalments on a Loan for Multiple Years Lecture 10

  10. Numerical Example for the Instalment Calculations Lecture 10

  11. Calculation of Instalment Payment on 20000 at 8.9 APR for 5Years (from the spreadsheet) D =20000 i = 8.9 APR Lecture 10

  12. Investment Questions • How much will amount grow if you invest £100 today at 10 percent interest rate in 100 years time? • What is the value of £100 that you will receive after 100 years if market interest rate is 10 percent? • What is the yield to maturity of a bond with face value £1000 which sells in the market for 100 and matures in 10 years time? • What is the yield to maturity if both face value and market prices are equal? • What is the value of a Share that has a face value of 1000 and promised to pay dividend growing at 3 percent and has a risk factor about 2 percent? Lecture 10

  13. More Investment Questions • How do you finance a investment project? • Self finance • Bond Finance • Stock Market • What determines value of a bond? • What is the value of a stock that now pays £1000 as dividend and promises this to grow by 3 percent every year if the market interest rate is 5 percent and risk premium is 8 percent? • How to make a decision to invest or not to invest? Lecture 10

  14. How does 100 invested today grows at different interest in 100 years Lecture 10

  15. Investors Care about the Real not the Nominal Interest Rate: Approximation Rule (Fisher Equation) Lecture 10

  16. Expectation and the financial market: Fisher equation Lecture 10

  17. Market Price of a console Lecture 10

  18. Value of Bonds and Maturity Lecture 10

  19. Higher Long Run Interest Rates are Better for Investment Lecture 10

  20. What is the Present Value of a Console that pays £100 every year for 100 years at various discount factors (interest rates) Lecture 10

  21. What is the Present Value of a Console that pays £100 every year and matures at a given year at Various interest rates Lecture 10

  22. Bond Market and Bond Prices Lecture 10

  23. Yield to maturity depends upon expected bond prices and interest rates Lecture 10

  24. Yield to maturity (Return on a bond that matures at year t) Lecture 10

  25. Government Borrowing (Million £) Source: Bank of England Lecture 10

  26. Stock Market and Stock Prices Lecture 10

  27. AIM Lecture 10

  28. Lecture 10

  29. Lecture 10

  30. Lecture 10

  31. Value of a Stock: An example Lecture 10

  32. Value of a Stock: An example Lecture 10

  33. Largest increases in equity market valuation - FTSE 100 Lecture 10

  34. Observations From the above Analysis of Stock Markets Lecture 10

  35. Lecture 10

  36. Lecture 10

  37. A Question on Investment Decision Lecture 10

  38. Investment Decision Analysis Lecture 10

  39. Exercises • Difference between real and nominal and short term and long term interest rates • Instalment payments • |Arbitrage conditions and Port-folio allocations in the financial markets • Value of a console • Market value of bonds and stocks • Life time income • Yield to maturity Lecture 10

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