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MACROECONOMICS (INTEREST RATE SPREADS AND MISMATCH (**INTEREST RATE…
MACROECONOMICS
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WHAT IS OF VITAL INTEREST TO A FINANCIAL MANAGER?
SHAPE OF THE YIELD CURVE AND SHIFTS IN THE SHAPE OF THE YIELD CURVE.
NORMAL YIELD CURVE: UPWARD SLOPING LONGER THE TERM HIGHER THE RETURNS
INVESTORS REQUIRE THAT LONGER TERM INVESTMENTS PROVIDE A HIGHER YIELD BECAUSEOF THE RISK OF CAPITAL LOSS IF RATES WERE TO RISE AND BECUASE OF REDUCED LIQUIDITY FORM LONGER TERM INVESTMENTS
INVERTED YIELD CURVE: WHEN SHORT TERM INTEREST RATES ARE HIGHER THAN LONG TERM. WHEN INVESTORS FEEL INTERERST RATES WILL FALL.
INVESTORS WILL PURCHASE LONGER TERM SECURITIES AS RATES BELOW THOSE ON SHORT TERM SECURITIES. THIS IS BECAUSE SHORT TERM RATES ARE GOING TO FALL AND WHEN THEIR INVESTMENTS MATURE THEY WILL RECEIVE A SMALLER RETURN ON WHAT THEY REINVEST
FLAT YIELD CURVE: WHEN THERE IS LITTLE DIFFERENCE BETWEEN LONG AND SHORT TERM INVESTMENTS. THIS IS A FRUSTRATING SITUATION FOR FINANCIAL MANAGERS AS IT IS DIFFICULT TO DECIDE TO INVEST LONG TERM OR SHORT TERM. ALSO REVENUES ARE FLAT.
HUMPED YIELD CURVE:
WHEN THERE IS A INFLECTION POINT SO ONE SIDE OF THE SLOPE IS DIFFERENT THAN THE OTHER. THIS IS DRIVEN BY INVESTORS EXPECTATIONS.
THEY FEEL INTEREST WILL RISE DUE TO INFLATION AND THEN THE BANK OF CANADA WILL INCREASE THEIR RATE TO STAVE OFF INFLATION. THIS RESULTS IN A STEEP YIELD CURVE FOR SHORT TERM MATURITIES AND LESS STEEP FOR LONG TERM
CHANGES IN THE SHAPE OF THE YIELD CURVE REFLECT THE FACT THAT SHORT TERM INTEREST RATES OFTEN CHANGE BY GREATER AMOUNTS AND FLUCTUATE MORE FREELY THAN LONG TERM INTERST RATES
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FORWARD INTEREST RATES; LOOKING AT TWO SUCCESSIVE POINTS ON A YIELD CURVE TO DETERMINE WHAT THE RATE OR YIELD WILL BE IN THE FUTURE.
THE REAL INTERST RATE: MARKET RATE (NOMINAL RATE) WHEN WE SUBTRACT INFLATION FROM THIS RATE WE ARE LEFT WITH THE REAL INTERST RATE,
LIQUIDITY PREFERENCE THEORY:
PRECAUTIONARY BALANCES ARE NOT SENSITIVE TO HIGER INTEREST RATES WHILE SPECULATIVE BALANCES ARE.
WHEN INTEREST RATES RISE PEOPLE WHO HAVE SET MONEY ASIDE FOR CAUTIONARY OR CONTIGENCY PURPOSES WILL NOT BE PERSUED TO INVEST IN LONG TERM ASSETS. SPECULATIVE BALANCE WILL HOWEVER.
INTEREST RATE IS THE COST OF MONEY;
FACTORS THAT AFFECT INTEREST RATES IS, TIME TO MATURITY AND RISK
INTEREST RATES ARE ESTABLISHED IN THE MARKET FOR MONEY BASED ON SUPPLY AND DEMAND. OTHER FACTORS THAT AFFECT INTEREST RATES IS MONETARY AUTHORITIES LIKE THE BANK OF CANADA AND THE FEDERAL RESERVE.
WEAKENING ECONOMY THE MONETARY AUTHORITIES WILL REDUCE SHORT TERM INTEREST RATES TO ENCOURAGE PEOPLE AND BUSINESS TO BORROW TO SPEND AND THUS BOOST THE ECONOMY
ANOTHER FACTOR INFLUENCING INTEREST RATES IS INFLATION; AS AN ECONOMY STRENTHENS THEN INTERST RATE RISE
INTEREST RATES AR CYCLICAL;
FOUR PHASE - RISING, THE PEAK, FALLING AND THE TROUGH.
DIRECTION OF RATE MOVEMENT MAY NOT BE UNIFORM AND CONSISTENT.
FOR EXAMPLE; IN A RISING PHASE THERE MAY BE A PERIOD WHEN RATES DECLINE AND THEN START TO RISE AGAIN
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LIQUIDITY PREFERENCE
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PEOPLE HOLD NON-INTEREST BEARING CASH FOR THREE REASONS:
TRANSACTIONS
PRECAUTIONARY OR AGAINST CONTINGENCIES OR UNFORSEEN EXPENDITURES
SPECULATIVE; OR WAITING FOR INTEREST RATES TO GO UP
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BOND AND MORTGAGE RATES ARE CORRELATED. LARGE MOVES IN THE RATE IN EITHER CATIGORY WILL RESULT IN A MOVE IN THE OTHER. THE REASON IS INVESTORS HAVE THE OPTION TO INVEST IN EITHER MARKET
INTEREST RATE CYCLE AND RISK: WHEN INTEREST RATES RISE THEN MORE BORROWERS DO NOT QUALIFY AND SOME DEFAULT.
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INFLATION AND INTEREST RATES ARE STRONGLY RELATED: WHEN INFLATION RISES INVESTORS WILL WANTED TO BE COMPENSATED BY GETTING A HIGHER RETURN FOR THE LOSS OF PURCHASING POWER DUE TO INFLATION
THE DIFFERENCE BETWEEN INTEREST RATE SPREAD AND MARGIN
interest rate spread is the difference between an asset yield and a liability cost.
a margin is the dollar amount of financial revenue less the dollar amount of financial expense for a portfolio and is often presented as a ratio
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INFLATION AND INTEREST RATES: INFLATION CAUSES INTEREST RATES TO GO UP BECAUSE LENDER DO NOT WANT TO RECEIVE LESS VALUE IN REPAYMENT THAN THEY LOANED OUT. INFLATION RISES INTEREST RATES RISE.
NOMINAL INTEREST RATE IS THE RATE IN THE MARKET,NOT ADJUSTED FOR INFLATION.
THE REAL INTEREST RATE HAS BEEN ADJUSTED FOR INFLATION: MARKET - INFLATION = REAL INTEREST RATE