Mishkin Case Study

Week 1 – Introduction – Financial Accounting (Review) Week 2 – Financial Markets and Net Present Value Week 3 – Present Value Concepts Week 4 – Bond Valuation and Term Structure Theory Week 5 – Valuation of Stocks Week 6 – Risk and Return – Problem Set #1 Due Week 7* – Midterm (Tuesday*) Week 8 - Portfolio Theory Week 9 – Capital Asset Pricing Model Week 10 – Arbitrage Pricing Theory Week 11 – Operation and Efficiency of Capital Markets Week 12 – Course Review – Problem Set #2 Due

Then, in the 1990s, bonds were created consisting of subprime mortgages, which were higher risk mortgages with high interest rates, made to borrowers with lower credit levels. Essentially, banks were handing out mortgages like candy to consumers who were never going to be able to make the payments, but Wall Street kept buying and packaging the mortgages into bonds. Since these bonds were inherently riskier, one wonders why investors were still willing to buy. Investors, who look at ratings by agencies such as Moodys and Standard & Poors, had no reason to believe these bonds were risky investments. The agencies, whom were being paid by Wall Street, were assigning high ratings to these risky bonds.

Caporale and Pittis (2000) highlight that policies on financial investments in one nation can impact the interest levels in a lateral area, but this is coupled with the local budget deficits in the country in question. The rate at which an economy expands is a local influence to the interest rates as well as the changes of wages laid out for the employees. The quota of funds borrowed by the civil authority to sustain the economy and the constant shifts in wealth accumulation for citizens, through unemployment rate changes impact interest rate levels. In 2008, the federal interest rate was at an astounding 6.5%, very high in comparison to the 0.5% rate enforced a few years later. Janda & Zetek (2013) add that the prices of entities and the living standards play a primary role in the swaying of interest rates. Awareness on investment openings available can be tagged as a factor affecting interest rates as it influences the level

The flow of funds within financial markets is stimulated by the money, bond and mortgage markets. A money market is the trading of highly liquid financial instruments with a duration of one year or less and includes the trading of Treasury bills. Furthermore, bonds are long term investments, with a duration greater than 1 year and are issued by corporations and the U.S. government. In addition, the mortgage market creates loans to finance the real estate market. Once mortgages are issued on a property, banking institutions securitize the mortgages and sell them on the secondary market (CSU Global, 2016). Due to the scale of these three markets they have an extensive impact on the monetary supply and economy.

reward — in the form of higher interest — than those who risk their money

In this task I am going to explain demand and supply in details. Demand is how much people wants from a certain product. While supply is how much of something people have. Demand and supply involve in everything in our life, for example if human being feels that they need a certain product they will start to produce it to meet their demand. Demand and supply curves always have an inverse relation which means if the demand increase the supple will decrease and vice versa.

“Individuals and businesses lend their savings to borrowers. In exchange, borrowers give lenders a debt instrument, which is called bonds, representing a promise by borrowers to pay interest income to lenders on the principal (the amount of money borrowed) until the principal is repaid to the lenders” (Feldstein & Fabozzi, 2011).

The market price of a good is determined by both the supply and demand for it. In the world today supply and demand is perhaps one of the most fundamental principles that exists for economics and the backbone of a market economy. Supply is represented by how much the market can offer. The quantity supplied refers to the amount of a certain good that producers are willing to supply for a certain demand price. What determines this interconnection is how much of a good or service is supplied to the market or otherwise known as the supply relationship or supply schedule which is graphically represented by the supply curve. In demand the schedule is depicted graphically as the demand curve which represents the

Supply reflects the quantity of a good or service that a producer is willing and able to supply the market at a given price at a particular period of time. As price increases, the quantity a producer is willing and able to offer for sale in the market increases. Price is the endogenous (internal) factor impacting the quantity offered in the market. This causes a shift in the supply curve, which is the relationship between the quantity that all firms are willing to supply and alternative prices of the services.

Some students have difficulty understanding the laws of supply and demand and the difference between changes in demand (supply), which are caused by changes in the respective determinates of demand or supply, and changes in quantity demanded (supplied) which result from changes in the price of the good or the service.

Investment grade corporates were not as affected by the post-election price free-fall experienced by other select sectors of the fixed income markets. Notwithstanding the correction in rates, corporates delivered a respectable total return in 2016. The Bloomberg Barclay’s Intermediate Corporate Index, which is a proxy for our investment grade strategy focus, earned 4% last year, outperforming the comparable Treasury index, which posted a 1% total return. As we begin the New Year, nominal rates are attractive, and corporates continue to offer a meaningful yield advantage over Treasuries. While valuations have narrowed from a year ago, current credit spreads are in line with multi-year averages and have room to compress further. The compelling entry point is further buoyed by expectations for lower net supply, due in part to a shallower pipeline of M&A activity and a heavy maturity schedule. We expect intermediate investment grade corporates to earn between 2%-3% this year, outpacing Treasuries.

Financial theory accepts the belief that a share’s return should be proportional to the risk received by its holder. There is a need of a risk-return equilibrium model. Since the nativity of the efficient market hypothesis (EMH), an equilibrium model was only the Capital Asset Pricing Model (CAPM). The CAPM constitutes of two types of returns, the risk free rate of returns of the Treasury bills and beta times the return on the market portfolio. The following equation is the basis of this model:

Some factors that can cause a shift in the supply curve include: technology, taxes, factor cost, and other alternative goods. Some factors that can cause a shift in the demand curve include: taste, a change in the consumer population, a change in income, and a change in other goods and availability. The graph for this week shows that both the supply and demand curves are shifting to the left. This means that both the supply and the demand are simultaneously decreasing in the market. This also means that the equilibrium price in the market has also decreased and shifted to the left as well. Business firms would view this graph as having negative progress in the market because this graph is telling business firms that they can no longer supply as much of their product as well as not many consumers are interested in their product anymore which as a result, are forced to drastically lower the price of the

Subprime mortgage loans issued by banks to finance mortgage-backed securities have led to a huge increase in both housing prices and the quantity of houses being built. If housing prices climb too high above their economic value, there will be no incentive for people to pay their mortgage. Borrowers may decide to default on their housing loans, and this will lead to a crisis in the real estate market which could result in a drastic decline of economic performance. The Federal Open Market Committee has a target of decreasing the federal funds rate 50 basis points, from 5.25 percent to 4.75 percent, and also decreasing the discount rate 50 basis points from 5.75 percent to 5.25 percent (“FOMC Statement,” 2007). The following graph can be used to show how an open market purchase will impact the market for bonds and result in the desired rate

The book starts by talking about the “bond” and how it is used to make interested payments on borrowed money and then gets paid back in the long-term. In the late 1980’s Wall Street had released that is could create products like credit cared, and home mortgages which were very similar in comparison to bonds themselves. The introduction of mortgage bonds allowed the beginning of home mortgages that is a huge part of the financial crisis of 2008. Within the 1990’s mortgage bonds were created that were a much higher risk; these mortgages are called “subprime.” Due to this addition to the market the risks people were taking on became something that they would not realize. Their actions would soon create the housing bubble that occurred and created this financial crisis years and years later.