Chapter 12 behaviour of markets

Question 1

Risk Profile of Government bond markets

Answer 1

Government bond from a developed country is secure and low risk
Marketability is usually good
Fixed-interest bonds cover inflation.

Question 2

Risk profile of corporate bond markets

Answer 2

Have a risk of default, inflation, liquidity and marketability.
Have higher expected return

Question 3

Equity markets

Answer 3

Have risk of default, liquidity, uncertainty of dividends.
Protect investors against inflation
Have Contagion risk

Question 4

Factors affecting short-term interest rates

Answer 4

Controlled by the government through the central bank intervention in the money market

Question 5

Reasons for altering interest rates

Answer 5

Control inflation - More money in the economy means a higher inflation
Control economic growth - Low interest rates increase spending and increases borrowing
Contol the exchange rate - If interest rates are low relative to other countries, international investors will be less inclined to deposit money, this decreases demand for the domestic currency and tends to decrease the exchange rate.
Quantitative easing -
Negative interest rates -

Question 5

Factors affecting the level of bond market

Question 6

Four theories of the yield curve

Answer 6

Expectations theory - The shape of the yield curve is determined by economic factors, which drive the market expectations for for future short-term interest rates
Liquidity preference theory - Investors prefer liquid assets to illiquid ones
Inflation risk premium theory - Investors want to be compensated by higher nominal yield for the risk that inflation is higher than expected and the real return is lower than expected
Market segmentation theory - Yields at each term to redemption are determined by supply and demand from investors with liabilities of that term