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International Financial Markets > Interest Rates > Flashcards

Interest Rates Flashcards

1
Q

What is the market value of securities (shares, bonds, etc.)?

A

The PV of all expected cash flows to the investor.

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2
Q

What are all the expected cash flows to the investor?

A
  • divident payments
  • interest payments
  • repayment of principal sum
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3
Q

What are the types of financial markets?

A
  • stock markets & bond markets
  • forex and derivative markets
  • capital markets
  • debt markets
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4
Q

What is a capital market?

A

It is a debt & equity market where companies raise their capital.

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5
Q

What are debt markets?

A
  • Money market (short-term)
  • Bond market (long-term)
  • This is the place where interest rates are determined.
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6
Q

What are the types of interest rates?

A
  • Simple vs compound interest
  • Nominal vs real interest rate
  • Short vs long term interest rates
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7
Q

What is the difference between real and nominal interest rate?

A

In a financial context we use the nominal interest rate, but the real interest rate is adjusted for inflation and reflects the economical situation.

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8
Q

What is the formula for real interest rate?

A

Real = nominal - inflation rate

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9
Q

Are short term or long term rates higher?

A

Long term interest rates are higher.

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10
Q

Why are long-term interest rates higher?

A

Because the longer we wait, the more uncertainty, the higher risk.

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11
Q

What is the short-term interest rate based on?

A
  1. Monetary policy (base rate - official rates and the interbank money market rate)
  2. International transactions money market
  3. Economic fundamentals (risk premium)
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12
Q

What is the central bank’s policy?

A

To have price stability and maximum employment.

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13
Q

What does price stability mean?

A

Inflation is at 2% (almost all central bank decisions are aimed at this inflation target)

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14
Q

What is the formula for the monetary equation of exchange?

A

M x V = P x T

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15
Q

What do the values in the monetary equation of exchange stand for?

A

M - money in circulation
V - velocity (frequency at which money is spent)
P - price level (inflation)
T - transactions (amount of goods and services in the economy)

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16
Q

What do the left and right side in the monetary equation of exchange represent?

A

Left side - money supply (total spending)
Right side - real economy (total GDP)

17
Q

What can the central bank do to adjust inflation?

A
  1. adjust the money supply
  2. adjust the interest rates
18
Q

What does the CB do when inflation is too high?

A

Decrease money supply
Increase interest rates

19
Q

What does the CB do when inflation is too low?

A

Increase money supply
Decrease interest rates

20
Q

What happens with velocity when interest rates go up?

A

Velocity goes down

21
Q

What happens with velocity when interest rates go down?

A

Velocity goes up (people want to spend more because it’s no longer lucrative to keep money in a savings account)

22
Q

What is a bond?

A

A long-term loan with fixed interest payments (coupons) and repayment at maturity.

23
Q

What is the yield to maturity (YTM)?

A

The return on the bond if you buy it and hold it until maturity.

24
Q

How is the long-term interest rate in a country derived?

A

It is the YTM on 10-year government bonds.

25
Q

How do you calculate return?

A

how much you get per yer / how much you paid

26
Q

How do you calculate YTM?

A

(coupon/bond price) + [((face value - bond price)/remaining years until maturity)] / bond price

27
Q

What changes bond yields?

A

Supply and demand for bonds determine the price and the only thing that changes and affects the yield is the price.

28
Q

What happens with the YTM if the price goes up?

A

It goes down

29
Q

What happens with the YTM if the price goes down?

A

It goes up

30
Q

Why does the yield move opposite to price?

A

Because you get the same cash flows always (coupon + principal), but you pay more/less

31
Q

What are the determinants of long-term interest rates?

A
  1. Economic fundamentals (business cycle, government budget balance, inflation)
  2. International transactions bond markets
  3. Monetary policy
32
Q

What are international transactions bond markets?

A

Interest rate differentials between countries, exchange rate expectations, economical and political stability

33
Q

What is quantitative easing?

A

Increasing money supply by buying government bonds.

34
Q

What does it mean for the YTM when the bond is trading at a discount?

A

YTM > coupon

35
Q

What does it mean for the YTM when the bond is trading at a premium?

A

YTM < coupon

International Financial Markets (9 decks)

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