Appunti esame Financial Institutions

Lezione 6

Expectations

Of returns, risk and liquidity -> asset demand

Inflationary expectations -> bond prices

Quantity demanded of an asset depends on

• Wealth: + wealth, + quantity
• Expected return: + expected return, + quantity
• Risk: + risk, - quantity
• Liquidity: + liquidity, + quantity

Efficient market hypothesis

Market in equilibrium: the optimal forecast of a security's return, using all available information, is equal to the security's equilibrium return.

Favorable evidence:

• Investment analysts and mutual funds don't beat the market:
  • Mutual funds that do well in one period, don't beat the market in the second.

Stock prices reflect publicly available information: an information already public is already reflected in the stock price. Also, favorable earnings announcements or stock splits do not cause stock prices to rise.

Stock prices and exchange rates close to random walk:

• If stock +, people buy until the equilibrium level
• If stock -, people sell to equilibrium level
• If stock predictable, price changes zero
• Technical analysis cannot successfully predict changes in stock price

Unfavorable evidence:

• Small-firm effect: they have earned abnormally high returns over long periods of time, even when the risk was considered.
• January effect: in January, stock prices experience an abnormal positive return. Investors sell stocks before the end of December (they can take capital losses on their tax return and reduce tax liability) and buy in January (driving up their prices and producing high returns).
• Market overreaction: stock prices overreact to news announcements. After the announcement of a decline, investors buy stock immediately and then sell them after a couple of weeks when the stock price rises back.
• Excessive volatility: fluctuations in stock prices may be much greater than expected.
• Mean reversion: stocks with low returns today tend to have high returns in the future, and vice versa. So, there will be a predictable positive change in the future price, suggesting that prices are not a random walk.
• New information is not always immediately incorporated into stock prices: stock prices do not instantaneously adjust to profit announcements. Stock prices continue to rise for some time after the announcement of unexpectedly high profits, and they continue to fall after surprisingly low profit announcements.

Lezione 7

Money markets

Solve cash-timing problems

Securities in the market are short term with high liquidity and low default risk, mature in 1 year or less.

Important because when a bank interest rate rises, depositors move their money to the money market.

Purpose

• Investors: warehousing surplus funds for short periods
• Borrowers: low-cost source of temporary funds
• Corporation and US government: use this because the timing of cash inflows and outflows is not synchronized

Who participates in the market?

Instruments

• Treasury bills: 28 days maturity, discounting concept, the treasury accepts competitive and noncompetitive bids, and the price paid is the highest paid to any accepted