Asset Prices and Interest rates Flashcards
(40 cards)
1
Q
Future value of dollar (definition)
A
- value of a dollar today in terms of dollars at some future time
2
Q
Future Value (formula)
A
1 dollar today = dollar . (1 + i)n
- “n” stand for years
- “i” stand for interest rate
3
Q
Present value of dollar (definition)
A
- value of a future dollar in terms of today’s dollars
4
Q
present value (PV) (formula)
A
1 dollar in “n” years = 1 dollar / (1 + i)n
- “n” stand for numbers of year
- “i” stand for interest rate
5
Q
Classical theory of asset prices
A
- the price of an asset equals the present value of expected income from the asset
asset price = present value of expected asset income
6
Q
what is a dividend ?
A
- payment from a firm to its stockholders
7
Q
what is Rational expectations ? (theory)
A
- Theory that people’s expectations of future variables are the best possible forecasts based on all available information
8
Q
Safe interest rate (isafe):
A
- interest rate that savers can receive for sure; also known as risk-free rate
9
Q
what is Risk premium ? (symbol of risk premium)
A
- Payment on an asset that compensates the owner for taking on risk
10
Q
what is Risk-adjusted interest rate ?
A
- sum of the risk-free interest rate and the risk premium on an asset,
(isafe + w)
- “W”using as Risk premium
- “isafe” stand for safe interest rate
11
Q
what is Gordon growth model ? (theory) (formula)
A
- Theory in which a stock price “P” is determined by an initial expected dividend, the expected growth rate of dividends, and the risk-adjusted interest rate
P = D1 / ( i – g )
- “D1” stand for initial expected dividend
- “g” stand for the expected grow rate of dividends
- “i” stand for the risk-adjusted interest rate
12
Q
When the Fed raises interest rates, what effects the stock market show?
A
- Higher safe interest rate.
- Higher interest rates reduce spending by consumers and firms
- higher risk premiums (still in debate)
13
Q
If the Fed raises interest rates, how the interest rate of economy’s safe is affected ? (stock effects)
A
- A higher safe rate reduces the present value of dividends received by stockholders, which decreases stock prices.
14
Q
If the Fed raises interest rates, how the risk premiums are affected ?
A
- A slower economy not only reduces expected earnings but also raises uncertainty
- it is hard to predict how badly companies will be hurt by the slowdown
- Greater uncertainty means higher risk premiums
- which raise risk-adjusted interest rates and decrease present values and stock prices.
15
Q
when the change of interest rate of the Fed is more effective ?
A
- Only when they are unexpected.
16
Q
Which assets prices are most volatile ?
A
- Long-Term Bond Prices: A change in interest rates has a larger effect on prices of long-term bonds than on prices of short-term bonds.
- Stock Prices: Prices for stocks are more volatile than prices for bonds, even long-term bonds
17
Q
why the Long-Term Bond Prices is more volatile than the short-term bonds ?
A
- The short-term bonds provide income only in the near future, whereas most payments on long-term bonds come later
- The present value of payments is affected more strongly by the interest rate if the payments come later.
18
Q
two main reasons by which the Stock prices fluctuate more ?
A
- Stocks yield income far into the future. (like long-term bonds)
- Changes in expected earnings add to the fluctuations caused by changes in interest rates
* The news about firms and the economy causes changes in expected earnings and dividends and thus in stock prices
19
Q
what is Asset-price bubble ?
A
- The rapid rise in asset prices that is not justified by changes in interest rates or expected asset income
20
Q
what is Price-earnings ratio (P/E ratio)?
A
- A company’s stock price divided by earnings per share over the recent past
21
Q
Meaning of Asset-price crash :
A
- A large and rapid fall in asset prices
22
Q
Meaning of “Margin requirements”: (crash prevention)
A
- Limits on the use of credit to purchase stocks - they have been around 50 percent of a person’ money.
23
Q
Meaning of “Circuit breaker” : (crash prevention)
A
- The requirement that a securities exchange shut down temporarily if prices drop by a specified percentage
24
Q
Meaning of “Yield to maturity” :
A
- The interest rate that makes the present value of payments from a bond equal to its price
25
Meaning of Capital gain:
* The increase in an asset holder’s wealth from a change in the asset’s price
26
Meaning of Capital loss:
* The decrease in an asset holder’s wealth from a change in the asset’s price
27
what is a "return" in stock and bonds ?
* The total earnings from a security;
* the capital gain or loss plus any direct payment (coupon payment or dividend); return
* (P1 –P0) + X
28
what is Rate of return?
* It is the return on a security as a percentage of its initial price;
**rate of return = (P1 – P0)/P0 + X/P0**
29
Rate of return **vs** Yield to maturity
* Both variables tell us something about how much you earn by holding the bond, But they can _behave quite differently._
* a decrease in a bond’s price can simultaneously cause:
1. _increase in the yield to maturity_ (because a bond’s price and its yield are inversely related)
2. _negative rate of return_ (because bondholders suffer capital losses).
30
If you are thinking of buying a bond, which variable should you care about? (Rate of return or Yield to maturity
* The answer depends on how long you are likely to hold the bond :
1. If you hold the bond until it matures, the yield to maturity tells what interest rate you receive, Fluctuations in the bond’s price are irrelevant _if you never sell the bond._
2. if you sell the bond after a year, you will receive the rate of return for the year. The yield to maturity does not matter _if you don’t hold the bond to maturity._
31
what is Nominal interest rate **( i )**?
* It is a interest rate offered by a bank account or bond
32
what is Real interest rate **(r)**? (formula)
* The _nominal interest rate_ minus _the inflation rate_;
**r = i - pi**
* **"r"** stand for **real rate**
* **"i"** stand for **nominal interest rate**
* **"pi"** stand for **inflation rate**
33
what is Ex ante real interest rate (rex ante) ?
* Nominal interest rate minus expected inflation over the loan period;
**rex ante = i - (pi)\*expected**
* **r**ex ante stand for **real interest rate previous**
* **"i"** stand for **nominal interest rate**
* **"pi\* "** stand for expected inflation
34
what is Ex post real interest rate (rex post) ?
* The _nominal interest rate_ minus _actual inflation_ over the loan period;
**rex post = i - pi(actual)**
* **"rex post"** stand for **actual real interest rate**
* **"i"** stand for **nominal interest rate**
* **"pi "** stand for **inflation**
35
what is Inflation-indexed bond?
* It is a bond that promises a fixed real interest rate;
* the nominal rate is adjusted for inflation over the life of the bond
36
**bond price (formula)**
**C/(1 + i) + C /(1 + i)2 + ... + C /(1 + i)t-1 + (C + F) /(1 + i)t**
* **"C"** stand for **annual coupon payment**
* **"i"** stand for **interest rate**
* **"t"** stand for **maturity (time)**
* **"F"** stand for **face value**
37
stock price (formula)
**D1 /(1 + i) + D2 /(1 + i) + D3 /(1 + i) + ...**
* **"D"** stand for **dividend**
* **"i"** stand for **interest rate**
38
The Classical Theory of Asset Prices (graph)
39
The Fed and the Stock Market (graph)
40
An Asset’s Rate of Return (formula)
**Rate of return = return / P0 = (P1 - P0)/P0 + X/P0**
* **"P0"** stand for the **initial price of the security**
* **"P1"** stand for **the price after you hold it for a year**
* **"X"** represents a **direct payment,** (X can be a coupon payment, C, or a dividend, D.)
