FINANCIAL MARKETS FINANCIAL MARKETS AND AND INTEREST RATESINTEREST RATES

FINANCIAL FINANCIAL MARKETSMARKETS

Are institutions and Are institutions and procedures that procedures that facilitate transactions facilitate transactions in all types of financial in all types of financial claims.claims.

CLASSIFICATIONS CLASSIFICATIONS OF OF

FINANCIAL MARKETSFINANCIAL MARKETS

* * PHYSICAL ASSET PHYSICAL ASSET MARKETS MARKETS – – “ tangible” or “real” asset “ tangible” or “real” asset markets.markets.

*FINANCIAL ASSET *FINANCIAL ASSET MARKETS- MARKETS- represent represent claims for future payment.claims for future payment.

*SPOT MARKET- *SPOT MARKET- trading trading mechanism use to move mechanism use to move funds on day to day funds on day to day basis.basis.

*FUTURE MARKET- *FUTURE MARKET- participants agree today participants agree today to buy for sale an asset at to buy for sale an asset at some future date.some future date.

* MONEY MARKET- * MONEY MARKET- all all institutions and procedures institutions and procedures that provide for transactions that provide for transactions in short term debt in short term debt instruments.instruments.

* CAPITAL MARKET- * CAPITAL MARKET- all all institutions and procedures institutions and procedures that provide for transaction that provide for transaction in long term financial in long term financial instruments.instruments.

* PRIMARY MARKET- * PRIMARY MARKET- market in which market in which corporations raise capital corporations raise capital by issuing new securities.by issuing new securities.

INITIAL PUBLIC OFFERING INITIAL PUBLIC OFFERING (IPO)- (IPO)- subset of primary market subset of primary market where in firms decides to sell where in firms decides to sell stocks to public for the first stocks to public for the first time.time.

* SECONDARY * SECONDARY MARKETS- MARKETS- markets in markets in which existing, already which existing, already outstanding securities are outstanding securities are traded among investors.traded among investors.

* PRIVATE MARKETS- * PRIVATE MARKETS- where transactions are where transactions are worked out directly worked out directly between two parts.between two parts.

* PUBLIC MARKETS- * PUBLIC MARKETS- markets in which standardized markets in which standardized contracts are traded on contracts are traded on organized exchanges.organized exchanges.

THE THE COST COST

OF OF MONEY MONEY

INTEREST RATE INTEREST RATE – is the – is the price paid to borrow debt price paid to borrow debt capital.capital.

o POINT OF VIEW OF POINT OF VIEW OF BORROWER BORROWER – the cost – the cost of borrowing money of borrowing money (borrowing rate)(borrowing rate)

o POINT OF VIEW OF POINT OF VIEW OF LENDER- LENDER- fee charged for fee charged for lending money lending money ( lending rate)( lending rate)

FACTORS OF FACTORS OF AFFECTING THE COST AFFECTING THE COST

OF MONEY OF MONEY

Time preferences for Time preferences for consumptionconsumption

Production opportunitiesProduction opportunities

RiskRisk

InflationInflation

DETERMINANTS DETERMINANTS OF MARKET OF MARKET

INTEREST RATEINTEREST RATE

Quoted interest Quoted interest raterate=k=k*+IP+DRP+LP+MRP=k=k*+IP+DRP+LP+MRP

• The real risk- Free rate The real risk- Free rate of interest, k- of interest, k- The rate of The rate of interest that would exist interest that would exist on default-free securities on default-free securities if no inflation were if no inflation were expected.expected.

• Nominal (Quoted) Risk- Nominal (Quoted) Risk- Free rate ,KRF- Free rate ,KRF- The rate The rate of interest on security that of interest on security that is free of all risk that is free of all risk that includes an inflation includes an inflation premium.premium.

• Inflation premium (IP)- Inflation premium (IP)- A premium equal to A premium equal to expected inflation that expected inflation that investors add to the real investors add to the real risk-free rate of return.risk-free rate of return.

• DEFAULT RISK DEFAULT RISK PREMIUM (DRP)- PREMIUM (DRP)- The The risk that a borrower will risk that a borrower will default on a loan.default on a loan.

• LIQUIDITY PREMIUM LIQUIDITY PREMIUM (LP)- (LP)- A premium added if A premium added if the security cannot be the security cannot be converted to cash on short converted to cash on short notice.notice.

• MATURITY RISK MATURITY RISK PREMIUM (MRP)- PREMIUM (MRP)- Risk associated with interest rate uncertainty. The longer the time to maturity, the higher the premium.

• REINVESTMENT RATE REINVESTMENT RATE RISK- RISK- Reinvestment risk is the risk that a bond is repaid early, and an investor has to find a new place to invest with the risk of lower returns.

Thank you! =)Thank you! =)