7.4 Evidence of Market Efficiency

 7.4 Evidence of Market Efficiency

Sophisticated statistical analyses of stock and other securities prices indicate that they follow a “random walk.” 

If securities prices in efficient markets are not random, and determined by fundamentals, particularly interest rate, inflation, and profit expectations. Why is random is their direction, up or down, in the next period?

That’s because relevant news cannot be systematically predicted. (If it could, it wouldn’t be news.) 

So-called technical analysis, the attempt to predict future stock prices based on their past behavior, is therefore largely a chimera. On average, technical analysts do not outperform the market. 

Three types of market efficiency: weak, semi-strong, and strong. Today, most financial markets appear to be semistrong at best.

In every age, financial markets tend to be more efficient than real estate markets, commodities markets, labor, and many services markets because financial instruments have a very high value compared to their weight, uniform quality, and little subject to wastage.

Futures markets have arisen to make commodities markets more efficient. 

Mortgage markets, also help to improve the efficiency of real estate markets.

Labor and services markets are the least efficient of all. People won’t or can’t move to their highest-valued uses; they adapt very slowly to technology changes; and regulations imposed by governments and others by labor unions, limit their flexibility on the job. 

Markets for education, healthcare, and custom construction services are also highly inefficient due to high levels of asymmetric information.

Many legitimate companies try to sell information and advice to investors. The value of that information and advice, however, may be limited. 

Even if the research is unbiased and good, by the time the newsletter reaches you, even if it is electronic, the market has probably already priced the information, so there will be no above-market profit opportunities remaining to exploit.

Only one investment advice newsletter, Value Line Survey (VLS), has consistently provided advice that leads to abnormally high risk-adjusted returns.

It isn’t clear if VLS has deeper insights into the market, if it has simply gotten lucky, or if its mystique has made its predictions a self-fulfilling prophecy: investors believe that it picks super stocks, so they buy its recommendations, driving prices up, just as it predicted! 

January Effect, the predictable rise in stock prices that for many years occurred each January until its existence was recognized and publicized. 

Financial securities, including stocks, tend to overshoot when there is unexpected bad news. After a huge initial drop, the price often meanders back upward over a period of several weeks. This suggests that investors should buy soon after bad news hits, then sell at a higher price a few weeks later. 

Sometimes, prices seem to adjust only slowly to news, even highly specific announcements about corporate profit expectations. That suggests that investors could earn above-market returns by buying immediately on good news and

selling after a few weeks when the price catches up to the news. 

The small-firm effect, returns on smaller companies, are abnormally large. Why then don’t investors flock to such companies, driving their stock prices up until the outsized returns disappear? Some suspect that the companies are riskier than researchers believe. 

The most important example of financial market inefficiencies is so-called asset bubbles or manias.

Periodically, market prices soar far beyond what the fundamentals suggest they should. During stock market manias, like the dot-com bubble of the late 1990s, investors apparently popped sanguine values forg into models like the Gordon growth model.

Our brains are pretty scrambled, especially when it comes to

probabilities and percentages. 

Behavioral finance uses insights from evolutionary psychology, anthropology, sociology, the

neurosciences, and psychology to try to unravel how the human brain functions in areas related to finance. [10] For example, many people are averse to short selling, selling (or borrowing and then selling) a stock that appears overvalued with the expectation of buying it back later at a lower price.

Human foible is that we tend to be overly confident in our own judgments. Many actually believe that they are smarter than the markets in which they trade.

Another source of inefficiency in financial markets is asymmetric information, when one party to a transaction has better information than the other.

Greater transparency and more fervent attempts to overcome the natural limitations of human rationality would help to move the markets closer to strong form efficiency.

References

Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation. Licensed under

      Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license.  

      Available from: https://www.saylor.org/site/textbooks/Money%20and%20Banking.pdf

How Do Information Systems Affect Market Efficiency?

 How Do Information Systems Affect Market Efficiency?

As we already know that the demand and supply are the reasons why stock prices are fluctuating like waves on the sea. And we also know that multiple factors would influence the waves' upper and drop. According to the price theory, if the market price of anything differs from the equilibrium price, market participants will bid the market price up or down until equilibrium is achieved. However, the equilibrium price is determined by the demand and supply which means they are influenced by factors like the prices of alternative goods, expectations, technology, income, preferences, the number of participants, natural events, government, regulations, and more. 

To Know The Price of Relative Investment Are Available

As we also know, these factors are also hugely influenced by information technology. For example, the prices of alternative goods, how do know that somewhere, has a cheaper alternative good that can increase your return before we have Google, the internet? Without these tools, how can you quickly get that kind of information to adjust your investment and your portfolio? It may take days or even longer for everyone to make a wise decision with poor information technology. Today, real-time news or podcasts can give you some pieces of information although they are not always right. But they do reduce the time we need to search for relative information and help us make decisions more quickly.

Expectations

How do predict the future of the price a stock and invest it before it becomes the next Tesla? You make your prediction and imagine the future with your own model. But how much information do you have in your brain? Or, just a dream? Information technology helps us make much more "real" decisions instead of just predict the dream can true.

The Number of Participants 

Recently, a very popular app called Robinhood helps many young and first-time traders in the US to build their first portfolios. The app helps tons of traders to quickly trade on the move with a single click and confirm, and hugely upsized the liquidity of the capital investment. Investors who value any particular asset most highly will click the buy button to own it, and more and more people have the opportunity to pay the most for it, therefore allocationally efficient. 

Reference
Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation. Licensed under Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license.

7.3 Financial Market Efficiency

 7.3 Financial Market Efficiency

If the market price of anything differs from the equilibrium price market participants will bid the market price up or down until equilibrium is achieved. 

The investor who values the asset most highly will come to own it because he’ll be willing to pay the most for it. Financial markets are therefore allocationally efficient. 

Where free markets reign, assets are put to their most highly valued use, even if most market participants don’t know what that use or value is. 

Financial markets are also efficient in the sense of being highly integrated which means prices of similar securities, or assets track each other closely over time, and prices of the same security trading in different markets are nearly identical.

Arbitrage, the profit opportunity that arises when the same security at the same time has different prices in different markets. By buying in the low market and immediately selling in the high market, an investor could make easy money. 

As soon as an arbitrage opportunity appears, it is immediately exploited until it is no longer profitable. (Buying in the low market raises the price there while selling in the high market decreases the price there.) Therefore, only slight price differences that do not exceed transaction costs persist.

The size of those price differences and the speed with which arbitrage opportunities are closed depending on the available technology. 

The transaction costs (fuel, tolls, hotels, and fees) are too high explains why people don't arbitrage the international price differentials of Big Macs, or any other physical things. However, online sites like eBay, or Amazon have recently made arbitrage in nonperishables more possible than ever by greatly reducing transaction costs.

After carefully studying all the transaction costs, the freight, insurance, brokerage, weighing fees, foreign exchange volatility, weight lost in transit, even the interest on money over the expected shipping time, the unit, the British ton (long ton, or 2,240 pounds), and the U.S. ton (short ton, or 2,000 pounds) are not the same thing. 

However, arbitrage and other unexploited profit opportunities do exist on occasion, not completely impossible.

In an efficient market, all unexploited profit opportunities and arbitrage opportunities, will be eliminated as quickly as the current technology set allows. 

In an efficient market, the optimal forecast return and the current equilibrium return are one and the same. For example, the rate of return on a stock is 10% but the optimal forecast or best rate of return, due to a change in information, was 15%. Investors would quickly bid up the price of the stock, thereby reducing its return. 

Financial market efficiency means that it is difficult or impossible to earn abnormally high returns at any given level of risk while returns increase with risk. 

Holding risk (and liquidity) constant, though, returns should be the same, especially over long periods. 

Many studies have shown that actively managed mutual funds do not systematically outperform the market.

7.2 Valuing Corporate Equities

 7.2 Valuing Corporate Equities

A corporate equity, stock, sometimes called a share. It is a share in the ownership of a joint-stock corporation. 

Ownership entitles investors to a say in how the corporation is run, usually means one vote per share in corporate elections for the board of directors, and monitor the corporation’s professional managers. 

Ownership also means that investors are residual claimants, entitling them to a proportionate share of the corporation’s net earnings (profits).

In exchange for their investment, stockholders may receive a flow of cash payments, usually made quarterly, called dividends. Unlike bond coupons, they are not fixed, it is not considered in default. 

The stock valuation method, the one-period valuation model, simply calculates the discounted present value of earnings and selling price over a one-year holding period:

P = E / ( 1 + k ) + P1 / ( 1 + k )

P = price now

E = yearly earnings or profit

k = required rate of return

P1 = expected price at year’s end

So if a company is expected to earn no profit, its share price is expected to be $75 at the end of the year, and the required rate of return on investments in its risk class is 10%, an investor would buy the stock if its market price was at or below P = 0/1.10 + 75/1.10 = $68.18. 

Another investor might also require a 10% return but think the stock will be worth $104 at the end of the year. He’d pay P = 0/1.10 + 104/1.1 = $94.55 for the stock today! 

What should be the price of a common stock paying $3.50 annually in dividends if the growth rate is zero and the discount rate is 8%?

P = 3.5 / (1+ 8%) + P / (1+8%) 

P = 43.75

If the next year’s dividend is forecast to be $5.00, the constant growth rate is 4%, and the discount rate is 16%, then the current stock price should be 42.67 (You can do it yourself)

What constant growth rate in dividends is expected for a stock valued at $37.82 if a $4.00 dividend has just been paid and the discount rate is 15%?

Suppose g = the constant growth rate

37.82 = 4 (1+ g) / (1+ 15% ) + 37.82 (1+ g) / (1+ 15%)

g = 4%

7.1 The Theory of Rational Expectations

 7.1 The Theory of Rational Expectations

The direction of price movements (up or down) is indeed random, but price levels are based on the rational expectations of a large number of market participants. 

Prices in those markets help to determine what gets made and what doesn’t, how much gets produced and how, and where and how those goods are sold.

Systematic manipulation of the market was impossible because the bulls and bears competed against each other, each tugging at the price, but ultimately in vain. 

As rational investors learned the tricks of trading, they came to expect hyperbole, false rumors, sham sales. 

In the final analysis, market fundamentals, not the whims of nefarious individuals, determined prices. 

Stock and other securities prices fluctuate due to changes in supply or demand, not because of the machinations of bulls and bears.

“The expectation of an event", creates a much deeper impression upon the exchange than the event itself.

Expectations are paramount, people invest based on what they believe the future will bring, not on what the present brings or the past has wrought, though they often look to the present and past for clues about the future. Rational expectations theory posits that investor expectations will be the best guess of the future using all available information. 

Expectations do not have to be correct to be rational; they just have to make logical sense given what is known at any particular moment. An expectation would be irrational if it did not logically follow from what is known or if it ignored available information. 

For the former reason, investors expend considerable sums on schooling, books, lectures to learn the best ways to reason correctly given certain types of information. 

Investors update their expectations, or forecasts, with great frequency, as new information becomes available, which occurs basically 24/7/365.

If everyone’s expectations are rational, then why don’t investors agree on how much assets are worth? Such differences in valuation are important because they allow trades to occur by inducing some investors to sell and others to buy. 

Investors sometimes have different sets of information available to them. Some investors may have inside information, news that is unknown outside a small circle. 

Investors think of the information they know in common differently because their utility functions differ, different holding periods, and different sensitivities to risk.

Investors use different valuation models, different theories of how to predict fundamentals most accurately and how those fundamentals determine securities prices. 

Financial crises almost always follow asset bubbles. Some investors understand the effect of some ripples more quickly and clearly than others. Investors often have a wide variety of opinions about the value of different assets. 

More mechanically, investors might have different opinions about bond valuations because they must have different views about the applicable discount or interest rate. 

PV=FV/(1+i)n

If this is a one-year zero coupon bond, FV = $1,000, and i = 6%, then the bond price = ($1,000/1.06) = $943.40. But if one believes i = 6.01, then the bond price = ($1,000/1.0601) = $942.51. To understand how investors can value the same stock differently, we must investigate how they value corporate equities.

Chapter 6 The Economics of Interest-Rate Spreads and Yield Curves Notes

 Chapter 6 The Economics of Interest-Rate Spreads and Yield Curves Notes

The 1930s, the Great Depression, dried up profit opportunities for businesses and hence shifted the supply curve of bonds left, further increasing bond prices and depressing yields. (If the federal government had not run budget deficits some years during the depression, the interest rate would have dropped even further.)

During World War II, the government used monetary policy to keep interest rates low. After the war, that policy came home to roost as inflation began. A higher price level puts upward pressure on the interest rate. 

Positive geopolitical events in the late 1980s and early 1990s, the end of the cold war, and the globalization, also helped to reduce interest rates by rendering the general business climate more favorable (thus pushing the demand curve for bonds to the right, bond prices upward, and yields downward). 

6.2 Interest-Rate Determinants I: The Risk Structure

Why the yields on Baa corporate bonds are always higher than the yields on Aaa corporate bonds?

Why bonds issued by the same economic entity with different maturities, have different yields, why the rank order changes over time?

Investors care mostly about three things: risk, return, and liquidity. 

Bonds issued by different economic entities have very different probabilities of default.

The U.S. government has never defaulted on its bonds and is extremely unlikely to do so, and its efficient tax administration (the Internal Revenue Service [IRS]) could always meet its nominal obligations by creating money. (That might create inflation) Except for a special type of bond called TIPS, the government promise to pay a nominal value, not a real [inflation-adjusted] sum, so the government does not technically default when it pays its obligations by printing money.)

Municipalities have defaulted on their bonds in the past and could do so again in the future because, although they have the power to tax, they do not have the power to create money at will. Nevertheless, the risk of default on municipal bonds (aka munis) is often quite low.

Munis are exempt from most forms of income taxation.

Corporations are more likely to default on their bonds than governments are because they must rely on business conditions and management acumen. 

Credit-rating agencies, including Moody’s and Standard and Poor’s, assess the probability of default and assign grades to each bond, the agencies are rife with conflicts of interest, and the market usually senses problems before the agencies do.

The most liquid bond markets are usually those for Treasuries. The liquidity of corporate and municipal bonds is usually a function of the size of the issuer and the amount of bonds outstanding. 

Corporate Baa bonds have the highest yields because they have the highest default risk, and not very liquid. 

Investors do not need as high a yield to own Treasuries as they need to own corporates. 

Corporate bond ratings go all the way down to C (Moody’s) or D (Standard and Poor’s), used to be called high-yield or junk bonds but are now generally referred to as B.I.G. or below investment-grade bonds.) 

Eager for tax-exempt income lead people to purchased large quantities of municipal bonds, driving their prices up (and their yields down) since, tax considerations, the highest income brackets exceed 30 percent.

The terrorist attacks on New York City and Washington, DC, in September 2001, some claimed that people who had prior knowledge of the attacks made huge profits in the financial markets. How would that have been possible?

The most obvious way would have been to sell riskier corporate bonds and buy U.S. Treasuries on the eve of the attack in expectation of a flight to quality, the mass exchange of risky assets (and subsequent price decline) for safe ones (and subsequent price increase).

6.3 The Determinants of Interest Rates II: The Term Structure

Holding the risk structure of interest rates, default risk, liquidity, and taxes, all constant. The term structure of interest rates, the variability of returns due to differing maturities. 

Even bonds from the same issuer, the U.S. government, can have yields that vary according to the length of time they have to run before their principals are repaid. 

Sometimes short-term Treasuries have lower yields than long-term ones, sometimes they have about the same yield, and sometimes they have higher yields.

The yields of bonds of different maturities (but identical risk structures) tend to move in tandem, and the yield curves usually slope upward. 

Sometimes, the yield “curve” is actually flat—yields for bonds of different maturities are identical, or nearly so.

Sometimes, particularly when short-term rates are higher than normal, the curve inverts or slopes downward, indicating that the yield on short-term bonds is higher than that on long-term bonds. 

Theory and empirical evidence both point to the same conclusion: bonds of different maturities are partial substitutes for each other, not perfect substitutes.

Generally, investors prefer short-term bonds to long-term ones, but they reverse their preference if the interest rate goes unusually high. 

There is one thing that can induce investors to give up their liquidity preference, their preferred habitat of short-term bonds: the expectation of a high interest rate for a short term. 

Investors think of a long-term bond yield as the average of the yields on shorter-term obligations, so when the interest rate is high by historical norms but expected after a year or so to revert to some long-term mean, they will actually begin to prefer long-term bonds and will buy them at much higher prices (lower yields) than short-term bonds. 

in = [ (ie0 + ie1 + ie2 + ie3 + .... ie (n − 1 ) ) / n ] + ρn

in = interest rate today on a bond that matures in n years

iex = expected interest rate at time x (0, 1, 2, 3, . . . through n)

ρ = the liquidity or term premium for an n-period bond.

The yield today of a bond with 5 years to maturity, if the liquidity premium is 0.5% and the expected interest rate each year is 4, is 4.5: i5 = (4 + 4 + 4 + 4 + 4)/5 + .5 = 20/5 + .5 = 4.5, implying an upward sloping yield curve because 4 < 4.5.

Short-term and long-term bonds issued by the same economic entity did not often differ much in price. 

One possibility is that there was no liquidity premium then. Short-term bonds suffered less interest rate risk than long-term bonds, but investors often complained of extremely high levels of reinvestment risk, of their inability to cheaply reinvest the principal of bonds and mortgages when they were repaid. Lenders often urged good borrowers not to repay, to continue to service their obligations. 

Another not mutually exclusive possibility is that the long-term price level stability, the interest rate less volatile. The expectation was that the interest rate would not long stray from its long-term tendency.

The yield curve as the market’s prediction of future short-term interest rates, by extension, an economic forecasting tool. Where the curve slopes sharply upward, the market expects future short-term interest rates to rise. Where it slopes slightly upward, the market expects future short-term rates to remain the same. Where the curve is flat, rates, it is thought, will fall moderately in the future. 

Empirical research suggests that the yield curve is a good predictor of future interest rates in the very short term, the next few months, and the long term, but not in between. 

Economic forecasters use the yield curve to make predictions about inflation and the business cycle. 

A flat or inverted curve, for instance, portends lower short-term interest rates in the future, which is consistent with a recession but also with lower inflation rates. 

A curve sloped steeply upward, by contrast, portends higher future interest rates, which might be brought about by an increase in inflation rates or an economic boom.

Reference

Wright, R. E. (2009). Money and Banking. Saylor Foundation. https://open.umn.edu/opentextbooks/formats/641. 

Products That The NYSE Offering

 Introduction

The New York Stock Exchange is an American stock exchange located at 11 Wall Street, Lower Manhattan, New York City. It is by far the world's largest stock exchange by market capitalization of its listed companies. The NYSE is owned by Intercontinental Exchange, an American holding company. Previously, it was part of NYSE Euronext (NYX), which was formed by the NYSE's 2007 merger with Euronext.

The New York Stock Exchange offers increased access to the capital that companies need to continue innovating and growing, while also placing new requirements. The NYSE also works closely with the management teams at NYSE-listed companies to understand their needs and develop efficient solutions that address the needs of their growing public businesses. The NYSE even provides some investor relations services such as market intelligence, stock insights, investor profiling solutions, corporate surveillance, communication tools, and more. 

Products That The NYSE Offering

Equities

Equity (also known as stocks or shares) is basically a part of the ownership of a company. For example, if my father's food company wants to raise its capital for expansion, and innovation, he can choose to sell the shares of his company and obtain funds from the public. 

NYSE provides a well-regulated market for this kind of need. NYSE regulates and oversees the responsibilities to protect the public investors and also support the business owners to grow their business successfully. NYSE’s also provides a unique market model that deep liquidity and high-quality quotes that lower volatility and the issuers' cost of capital. 

Options

Options are financial instruments that are derivatives based on the value of underlying securities such as stocks. Let's make it easier to understand. If you have an options contract with an issuer, you can choose to sell a certain amount of shares of a particular company or to buy them. That's why it's called options. You have two options and the choice is on you. Depending on the type of contract you hold, an options contract offers the buyer the opportunity to buy or sell the underlying asset. 

Each option contract will have a specific expiration date by which the holder must exercise their option, which means they must make their choices that are bought or sold. One thing that the investors have to pay attention, is the stated price on an option is known as the strike price which means the options owners take their actions under the agreements.

Equity options give an investor the right but not the obligation to buy a call or sell a put at a set strike price prior to the contract’s expiry date. NYSE Arca’s price-time priority model that provides enhanced throughput and encourages market makers to offer the best possible price.

Index options are another way for people to want to follow the bigger market, and make it possible for investors to trade an entire market to seek either profit or protection from price movements in a stock market as a whole.

Exchange-Traded Products

Exchange-traded products (ETPs) are types of securities that track underlying securities such as an index, or other financial instruments. One of the attractive parts of ETPs is they are traded on exchanges similar to stocks meaning their prices can fluctuate from day-to-day. The difference is that the prices of ETPs are derived from the underlying investments that they track.

Exchange-Traded Funds (ETFs) is a very common Exchange-traded product, its fund contains a basket of investments that can include stocks and bonds. An ETF usually tracks an underlying index such as the S&P 500, the Dow, or follow an industry, commodities, or a particular currency. If these underlying index goes down, the ETF goes down as well. In contrast, If these underlying index goes up, the ETF goes up. These products trade throughout the day just as a stock would trade.

Exchange-traded notes (ETNs) also track an underlying index of securities. ETN issuers promise to pay investors the return received from the index they track at the maturity date. However, the ETNs themselves do not actually own any particular assets, the issuers even allow to use the funds to obtain any assets they want. Therefore, ETNs are similar to bonds in that investors receive the return of their original invested amount at maturity, but the ETN does not pay periodic interest payments. Also, investors who buy ETNs do not own any of the securities in the index they track. 

Reference

New York Stock Exchange. (2020, September 04). Retrieved September 05, 2020, from https://en.wikipedia.org/wiki/New_York_Stock_Exchange

The Intercontinental Exchange. (n.d.). Retrieved September 05, 2020, from https://www.nyse.com/index

Chen, J. (2020, March 31). A Look at the Types of Exchange Traded Products (ETPs). Retrieved September 06, 2020, from https://www.investopedia.com/terms/e/exchange-traded-products-etp.asp

Chapter 4 Interest Rates Notes

 Chapter 4  Interest Rates Notes

Interest, the opportunity cost of money. Interest rate is the price of borrowing money.

If rates are low, businesses will be more likely to borrow money, expand production, and hire you. 

If rates are high, businesses will be less likely to expand or to hire you.

Interest = the payment it takes to induce a lender to part with their money for some period of time.

To measure interest rates, yield to maturity, the method preferred by economists for its accuracy. 

To compare the value of money today, called present value(PV and aka present discounted value or price), to the value of money tomorrow, called future value (represented here by the variable FV).

4.2 Present and Future Value

Money today is always worth more than money tomorrow. It means to forgo so many opportunities and the quality of life for a period of time. 

Paying interest on the interest every year, called annually compounding interest.

FV = PV(1 + i)n

FV = the future value (the value of your investment in the future) 

PV = the present value (the amount of your investment today)

(1 + i)n = the future value factor (aka the present value factor or discount factor in the equation below) 

i = interest rate 

n = number of terms (here, years; elsewhere days, months, quarters)

A higher interest rate means a higher opportunity cost for money. 

Question: 

$100 million payable in $5 million installments over 20 years! Did you really win $100 million? (Hint: Calculate the PV of the final payment with interest at 4 percent.)

FV = PV(1 + i)^n

PV = FV / (1+i)^n

The money payable next year and in subsequent years is not worth $5 million today. For example, the last payment, with interest rates at 4 percent compounded annually, has a PV of only 5,000,000/(1.04)^20 = $2,281,934.73. 

4.3 Compounding Periods

Interest does not always compound annually. Sometimes it compounds quarterly, monthly, daily, even continuously. The more frequent the compounding period, the more valuable the bond or other instrument, all else constant. 

$1,000 invested at 12 % for a year compounded annually = $1,000 × (1.12)^1 = $1,120.00. 

Compounded monthly

12%/12 months = 1% per month

$1,000 × (1.01)^12 = $1,126.83 

*Notice

i as the interest paid per period (.12 interest/12 months in a year = .01) and n as the number of periods (12 in a year; 12 × 1 = 12), rather than the number of years. 

Compounded quarterly

$1,000 × (1.03)^4 = $1,125.51. 

Compounded annually

$1,000,000 × (1.04) = $1,040,000

The same terms compounded quarterly

$1,000,000 × (1.01)4 = $1,040,604.01. 

4.4 Pricing Debt Instruments

4 major types of instruments

Discount coupon bonds, Simple loans, Fixed-payment loans, and Coupon bonds. 

A discount bond (zero-coupon bond) makes only one payment, its face value on its maturity or redemption date, so its price is easily calculated using the present value formula.

A simple loan is a loan where the borrower repays the principal and interest at the end of the loan. Use the future value formula to calculate the sum due upon maturity. 

A fixed-payment loan (fully amortized loan) is one in which the borrower periodically (weekly, bimonthly, monthly, quarterly, or annually) repays a portion of the principal along with the interest. Like auto loans and home mortgages, all payments are equal. There is no big balloon or principal payment at the end because the principal shrinks, slowly at first but more rapidly as the final payment grows nearer.

Web sites tools for calculation

http://ray.met.fsu.edu/cgibin/amortize

http://www.yona.com/loan/

http://realestate.yahoo.com/calculators/amortization.html. 

If you wanted to buy this mortgage (to purchase the right to receive the monthly repayments of $2,997.75) from the original lender, you’d simply sum the present value of each of the remaining monthly payments. 

A coupon bond makes one or more interest payments periodically (for example, monthly, quarterly, semiannually, annually, etc.) until its maturity or redemption date, when the final interest payment and all of the principal are paid. 

The sum of the present values of each future payment = the price. 

Exp. A $10,000 face or par value coupon bond that pays 5% interest annually until its face value is redeemed (its principal is repaid) in exactly five years:

PV1 = $500/(1.06) = $471.70 (This is the interest payment after the first year.)

The $500 is the coupon or interest payment = $10,000 x “coupon rate" = $10,000 × .05 = $500

PV2 = $500/(1.06)^2 = $445.00 

PV3 = $500/(1.06)^3 = $419.81

PV4 = $500/(1.06)^4 = $396.05 

PV5 = ($10,000+$500)/(1.06)^5 = $10,500/(1.06)^5 = $7,846.21

4.5 The Yield

Suppose you have $1,000 to invest for a year and two ways of investing it: a discount bond due in one year with a face value of $1,000 for $912 or a bank account at 6.35 percent compounded annually. Which should you take?

The bond

The yield = 9.65 % = (1000 − 912)/912 = .0965

Bond Prices After Terrorism Ended

 What will happen to bond prices if terrorism ended and the world’s nations unilaterally disarmed and adopted free trade policies? 

If terrorism ended and adopted free trade policies, that make people feel safe, stable, and expect the economy will be booming in the near future. Therefore, they tend to transfer their safe assets to some risky ones, like sell their Treasury bonds and buy stocks. Or, even sell their gold in the safe that purchased during the risky period, to buy flight tickets, pay for their travel plan. Overall, the bond prices will go down due to the lower demand. 

But, what if the government increased their issuing of bonds to win the war? After the terrorism, the government will be tossing and turning when their lenders, their people want their money back. To solve the problem, the government can just issue more bonds and that looks like you pay your short-term debts by creating a longer one. That will lose people's trust and causes even lower demand. 

The free trade policies will stimulus business owners to expand their business and causes the money demand to go up since they need more money to invest in their new business. Under a free trade policy, goods and services can be bought and sold across international borders with little or no government tariffs, quotas, subsidies, or prohibitions to inhibit their exchange.(Barone, 2020) Firms will tend to issue new bonds to raise their capital and causes the supply of corporate bonds to go up. The corporate bonds are an alternative choice for Treasury bonds or any other bonds, so the increase in corporate bonds supply will affect the bond prices of the other types. But the Treasury bonds have often been regarded as a safety one, corporate bonds are relatively risky. In the bonds market, different types and terms of bonds will be very different in price changing. Some will go down, but some will not.

Reference

Bond Prices, Rates, and Yields. (n.d.). Retrieved September 12, 2020, from https://www.fidelity.com/learning-center/investment-products/fixed-income-bonds/bond-prices-rates-yields

Barone, A. (2020, August 28). How a Free Trade Agreement (FTA) Works. https://www.investopedia.com/terms/f/free-trade.asp.