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Lecture 101 Macroeconomic Analysis Financial Market and Expectations.

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1 Lecture 101 Macroeconomic Analysis Financial Market and Expectations

2 Lecture 102 Contents Financial system and its importance in the Economy Determination of Instalment payments Growth of funds and their present values Fisher Equation: Real and nominal interest rates Bond market: Value of bonds and yield to maturity Arbitrage condition Stock market: value of stocks by the interest rate, risk premium and growth of dividends Investment decision problem Impact of changes in the interest rate in the price of assets

3 Lecture 103 Y= F(K,L) S C T Funds KFA Equity Treasury Bonds Deposit Banks Pension Funds Profit Link Between Financial System and the Economy

4 Lecture 104 Savers Households, Corporations and Government Intermediaries Banks, Insurance Companies, Building Societies, Trusts, Stock and Bonk Markets Intermediaries Banks, Insurance Companies, Building Societies, Trusts, Stock and Bonk Markets Investors Small, Medium and Large Private, Public, Domestic and Foreign Investors Small, Medium and Large Private, Public, Domestic and Foreign Major Players in a Financial Market CENTRALBANKCENTRALBANK CENTRALBANKCENTRALBANK GOVERNMENT&FSAGOVERNMENT&FSA GOVERNMENT&FSAGOVERNMENT&FSA CATS

5 Lecture 105 Financing an Investment Project Self Finance Bequests Bonds: Debt Finance Banks, Building Society, Insurance Equity Finance Stock Market (LSE) No Risk High Risk Maturity Instalment Method Repayment Method Financing of an Investment Project Demand for output Need for Capital

6 Lecture 106 Calculations of Instalments on a Loan: Lower Interest Rate Reduces the Interest Payment

7 Lecture 107 Numerical Example for the Instalment Calculations

8 Lecture 108 Calculation of Instalment Payment on at 8.9 APR at 12 Instalments (from the spreadsheet) D =20000 i = 8.9 APR

9 Lecture 109 Calculations of Instalments on a Loan for Multiple Years

10 Lecture 1010 Numerical Example for the Instalment Calculations

11 Lecture 1011 Calculation of Instalment Payment on at 8.9 APR for 5Years (from the spreadsheet) D =20000 i = 8.9 APR

12 Lecture 1012 Investment Questions How much will amount grow if you invest £100 today at 10 percent interest rate in 100 years time? What is the value of £100 that you will receive after 100 years if market interest rate is 10 percent? What is the yield to maturity of a bond with face value £1000 which sells in the market for 100 and matures in 10 years time? What is the yield to maturity if both face value and market prices are equal? What is the value of a Share that has a face value of 1000 and promised to pay dividend growing at 3 percent and has a risk factor about 2 percent?

13 Lecture 1013 More Investment Questions How do you finance a investment project? –Self finance –Bond Finance –Stock Market What determines value of a bond? What is the value of a stock that now pays £1000 as dividend and promises this to grow by 3 percent every year if the market interest rate is 5 percent and risk premium is 8 percent? How to make a decision to invest or not to invest?

14 Lecture 1014 How does 100 invested today grows at different interest in 100 years

15 Lecture 1015 Investors Care about the Real not the Nominal Interest Rate: Approximation Rule (Fisher Equation)

16 Lecture 1016 Expectation and the financial market: Fisher equation

17 Lecture 1017 Market Price of a console

18 Lecture 1018 Value of Bonds and Maturity

19 Lecture 1019 Higher Long Run Interest Rates are Better for Investment

20 Lecture 1020 What is the Present Value of a Console that pays £100 every year for 100 years at various discount factors (interest rates)

21 Lecture 1021 What is the Present Value of a Console that pays £100 every year and matures at a given year at Various interest rates

22 Lecture 1022 Bond Market and Bond Prices

23 Lecture 1023 Yield to maturity depends upon expected bond prices and interest rates

24 Lecture 1024 Yield to maturity (Return on a bond that matures at year t)

25 Lecture 1025 Government Borrowing (Million £) Source: Bank of England

26 Lecture 1026 Stock Market and Stock Prices

27 Lecture 1027 AIM

28 Lecture 1028

29 Lecture 1029

30 Lecture 1030

31 Lecture 1031 Value of a Stock: An example

32 Lecture 1032 Value of a Stock: An example

33 Lecture 1033 Company Market Capitalisation As At 31st December 2002 % Increase since 31st December 2001 Reckitt Benckiser8,49934% Gallaher Group4,01632% Liberty International Plc1,76532% SAB Miller4,75021% National Grid Transco14,11219% Associated British Foods4,64917% Imperial Tobacco Group5,49716% Scottish & Newcastle3,94416% Rexam1,84615% Kingfisher5,81312% Largest increases in equity market valuation - FTSE 100

34 Lecture 1034 Observations From the above Analysis of Stock Markets

35 Lecture 1035

36 Lecture 1036

37 Lecture 1037 A Question on Investment Decision

38 Lecture 1038 Investment Decision Analysis

39 Lecture 1039 Exercises Difference between real and nominal and short term and long term interest rates Instalment payments |Arbitrage conditions and Port-folio allocations in the financial markets Value of a console Market value of bonds and stocks Life time income Yield to maturity


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