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Financial Markets and Institutions: 13 Edition
Financial Markets and Institutions: 13 Edition
13th Edition
by Jeff Madura
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7 Determination of Interest Rates
Chapter Objectives
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2
Background on Bonds (1 of 4)
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Background on Bonds (2 of 4)
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Exhibit 7.2 Participation of Financial
Institutions in Bond Markets
FINANCIAL INSTITUTION PARTICIPATION IN BOND MARKETS
Commercial banks and savings • Purchase bonds for their asset portfolio.
and loan associations (S&Ls) • Sometimes place municipal bonds for municipalities.
• Sometimes issue bonds as a source of secondary capital.
Finance companies • Commonly issue bonds as a source of long-term funds.
Mutual funds • Use funds received from the sale of shares to purchase
bonds. Some bond mutual funds specialize in particular types
of bonds, whereas others invest in all types.
Brokerage firms • Facilitate bond trading by matching up buyers and sellers of
bonds in the secondary market.
Investment banking firms • Place newly issued bonds for governments and corporations.
They may place the bonds and assume the risk of market
price uncertainty or place the bonds on a best-efforts basis; in
the latter case, they do not guarantee a price for the issuer.
Insurance companies • Purchase bonds for their asset portfolio.
Pension funds • Purchase bonds for their asset portfolio.
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Background on Bonds (3 of 4)
Bond Yields
• Yield from the Issuer’s Perspective
• Commonly measured by the yield to maturity.
• The yield to maturity is the annualized discount rate that equates
the future coupon and principal payments to the initial proceeds
received from the bond offering.
• Yield from the Investor’s Perspective
• Holding period return is used by bond investors who do not hold
the bond until maturity.
• Yield consists of two components:
(1) a set of coupon payments and
(2) the difference between the par value that the issuer must pay to
investors at maturity and the price it received when selling the bonds.
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Background on Bonds (4 of 4)
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Exhibit 7.3 Yield Offered on General
Obligation Municipal Bonds over Time
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Treasury and Federal Agency Bonds (1 of 6)
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Treasury and Federal Agency Bonds (2 of 6)
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Treasury and Federal Agency Bonds (3 of 6)
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Treasury and Federal Agency Bonds (4 of 6)
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Treasury and Federal Agency Bonds (5 of 6)
Savings bonds
• Issued by the Treasury, but they can be purchased from
many financial institutions.
• Can be purchased with as little as $25.
• Interest income on savings bonds is not subject to state and
local taxes but is subject to federal taxes.
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Treasury and Federal Agency Bonds (6 of 6)
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Municipal bonds (1 of 4)
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Municipal bonds (2 of 4)
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Municipal bonds (3 of 4)
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Corporate Bonds (1 of 10)
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Corporate Bonds (2 of 10)
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Corporate Bonds (3 of 10)
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Corporate Bonds (4 of 10)
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Corporate Bonds (5 of 10)
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Corporate Bonds (6 of 10)
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Corporate Bonds (7 of 10)
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Corporate Bonds (8 of 10)
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Corporate Bonds (9 of 10)
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Corporate Bonds (10 of 10)
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Globalization of Bond Markets (1 of 2)
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Globalization of Bond Markets (2 of 2)
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Other Types of Long-Term Debt
Securities (1 of 2)
Structured Notes
• The amount of interest and principal to be paid is based on
specified market conditions(ex.: price index, unpredictable
economic condition, and etc.).
• Risk of Structured Notes
• In the early 1990s, Orange County, California, suffered
losses and filed for bankruptcy due to investments in
structured notes.
• Because of the difficulty in assessing the risk of structured
notes, some investors rely on credit ratings. However, credit
rates of structured notes have not always served as accurate
indicators of risk.
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Other Types of Long-Term Debt
Securities (2 of 2)
Exchange-traded notes
• Debt instruments in which the issuer promises to pay a
return based on the performance of a specific debt index.
• Typically mature in 10 to 30 years and are not secured by
assets.
Auction-rate securities
• A way for borrowers (e.g., municipalities and student loan
organizations) to borrow for long-term periods while relying
on a series of short-term investments by investors.
• Every 7 to 35 days, the securities can be auctioned off to
other investors, and the issuer pays interest based on the
new reset rate to the winning bidders.
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SUMMARY (1 of 2)
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SUMMARY (2 of 2)
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