Liquidity preference theory PDF

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Liquidity preference theory – upward sloping curve Liquidity Preference Theory is a model that suggests that an investor should demand a higher interest rate or premium on securities with long-term maturities that carry greater risk because, all other factors being equal, investors prefer cash or other highly liquid holdings. Longer the period of the investment, you need to pay liquidity premium. So, the yield curve is shifted upward.

Segmentation / Preferred Habitat theory – Securities of different maturities are not alternatives for each other. The preferred habitat theory states that the market for bonds is 'segmented' by term structure and that bond. The bond issuer borrows capital from the bondholder and makes fixed payments to them at a fixed (or variable) interest rate for a specified period. market investors have preferences for these segments.

Market expectation theory – Securities of different maturities are alternatives for each other. Expectations theory attempts to predict what short-term interest rates will be in the future based on current long-term interest rates. The theory suggests that an investor earns the same interest by investing in two consecutive one-year bond investments versus investing in one two-year bond today.

Treasury note is government issue. So, the rate is the lowest. Bank overdraft rate is the riskiest as it has the most yield.

BAB = Bank accepted bill. It is not issue by a bank; bank is just a guarantor.

Discount = price is below the face value. CP = Commercial paper CD = Certificate of deposit Capital market is long run (more than 1 year). Money market is short run (less than 1 year). It is can also be one day interest. You borrow it today and pay it tomorrow. Money market is wholesale.

Demand curve for loanable funds the lower the interest rates, the greater the demand for funds. (shift downward.)

Supply curve for loanable funds If people want to save more, they will save more at every possible interest rate, which is a shift to the right of the supply curve. If people want to save less (MPS goes down), then the supply of loanable funds shifts to the left.

FV =PV (1+r )n a) 2

FV =10 000(1+0.03) FV =10 609 b)

8

FV =10 000 ( 1+ 0.0075 )

FV =10 615.99 c)

PV =10 000 ( 1+ 0.03 )−2

PV =9 425.96 d)

PV =10 000 ( 1+ 0.0075 )−8

PV =9419.75

Two ways for a company to borrow money. -

One way is for a company is to issue bills. From a bill is Big / Small Another way is company borrow from bank (traditional bank loan)

Bank will give you the quote. The quote will represent the first number is bigger and the second number is smaller. 3.20 / 95  3.20 / 2.95 Bank Bill (Big / Small) Remember: Borrow is always at higher rate  For example, I am borrowing money from bank to buy a house. Lend is always at lower rate  For example, I am lending my money to bank to deposit. Buy a commercial bill = lending money Selling a commercial bill = borrowing money Determine which side? Base on lending and borrowing. Since I am borrowing, it is left side. Then now decide which has lower rate, obviously it is 3.10% (Bank B) because it is lower than 3.20% (Bank A)

They are not issuing a bill. They are taking a bank loan. When you take a bank loan, the first number is small, and the second number is big. Bank Loan (Small / Big) Borrow at higher rate. Lend at lower rate. Thus, borrow rate is at right side for this. Take Bank Y (4.20%) as it has lower rate compare to Bank X (4.95%).

Price maker (Bank) Will buy (borrow) at lower rate.  Bid is the buying rate of price maker. Will sell (lend) at higher rate.  Offer is the selling rate of price maker. Price Taker (Company or individual) Will buy (borrow) at higher rate. Will sell (lend) at lower rate.

Issue price for A

¿

100 000 90 1+(0.09)( ) 365

¿ 97 829.00 Net proceeds for B = Issue price – Fee = 98 000 – 4 000 = 94 000

a) Bought a 180-day BAB

¿

1000 000 180 1+(0.06)( ) 365

¿ 971 261.31 Sold at price (60-day later)

¿

1000 000 120 1+( 0.05 )( ) 365

¿ 983 827.49 Profit = b) Price

983 827.49−971261.31= 12566.18

¿

FV 1+( y )( t )

1 000 000 997 540.31= 30 1+( y )( ) 365 997 540.31[ 1+( y )

30 ( 365 ) ]=1 000 000

1+( y )

30 ( 365 )=1.002465755

y = 0.03 = 3%...