Summary
Summary Money and Banking part 2
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Summary Money and Banking part 2
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Lecture 1Yield to
maturity Rate of return
YTM is the interest rate that matches A coupon band bought at time t and
/ price with the sold at t has
present
-11
today 's value
RET Re C + Pe Pt
future
= = -
value of all cash flows .
c- + i
Pt
PV CF
Pete
=
"
=
( +
,
-
Pt
Citi )
p , Pt
Credit market instruments
=
ic +
ge
where ic and
= current
yield
1 simple loan
2 Fixed
ge = rate of expected capital gain .
payment loan
-
3 coupon bond key facts maturity and returns
4 Discount ( ) bond
1 If return =
yield then
ze ro -
coupon
maturity =
holding period and vice
Relation YTM
price and versa .
1 Price and YTM a re
negatively related 2 If maturity >
holding period and
P t
"
2 the bond traded
"
at then it then
resulting in capital
If is
par ,
,
loss
price equal to its face value and
.
is
the YTM
3 The effect of interest rate changes
equals the coupon rate
is
larger for long maturities
3
.
YTM rate
>
coupon if bond price
4 The change in return becomes
larger
is below
par
when maturity increases if
Consol interest rate
changes .
A perpetuity or consol is a bond without 5 Bond with high initial interest rate
date ,
maturity so
principal is not payed and/or coupon rate can end up
continue
back and coupon payments with a
negative rate of return
forever .
if it .
Pc = C
Interest rate risk
ic
This approximation
longer term bonds react
stronger to
gives an
easy for
changes in interest For
any bond
the YTM bond
.
of a which is m o re
,
which is held for the entire maturity ,
precise if price is near
par and
long
there is no interest rate risk .
maturity .
Fisher equation
'
c- = r + He ,
ir = r =
i -
IT
when the real interest rate is lower ,
people a re m o re willing to borrow .
S. Veeling
,*
Unfolding of the crisis
"
"
Borrowers
Originate to distribute model suffers from agency problems .
did not information their ability to and banks commercial
gave on
pay ,
and investment , had low incentive to assess the quality of
securities .
Also ,
the
housing bubble bursts .
People cannot repay
their Sub-prime banks start the
mortgages ,
so
selling
houses which made housing to drop More
collateral ,
prices .
" "
and m o re
people had underwater
mortgages . That caused
the ABSS to out less so
ratings for ABSS we re
dropped
pay
.
,
as result also the demand ABCP and
a
, for decreased
"
SIUS came into liquidity problems and a run on the
"
shadow banking system started .
S1U could use credit lines or
sell ABSS to be able ABCPS
quickly of to
pay off maturing .
Banks had immediate liquidity problems due to the credit
lines ,
but also made losses on ABSS they had in their
portfolio . Interbank money
market starts
drying up as banks
have themselves Sales
money they
need all the .
of products
go down that deteriorate the balance sheet of the bank and
the capital of the bank . Also banks have solvency problems ,
losses in the value of assets that erode capital .
Banks without
government guarantee go bankrupt .
+ Reaction of CBS and fiscal authorities
To e as e the credit crunch , central banks lowered interest
rates liquidity broadened the allowed
,
provided ,
type of
collateral lengthened the Banks
and
maturity of lending .
cut back on
lending to firms and consumers due to
weakened balance Crisis
uncertainty and sheets .
becomes a
world wide crisis .
S. Veeling
, Lessons
→
CB should avoid driving up prices of assets by keeping
interest low .
*
Regulators should react
quicker .
→
Improve micro -
and macro
prudential regulation .
* Better regulation of rating agencies .
no assessment of bank
by measuring profits
managers
* .
→
Dealing better with collapsed banks .
S. Veeling
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