FIN 433

FIN 433
Exam 1 syllabus
Chapter 1 Financial markets and institutions
Chapter 2 Interest rates
Chapter 4 Central bank
Chapter 6 Money market
Chapter 7 Bond market

Chapter 1
Financial markets
Financial markets
markets in which financial
assets (securities) can be
purchased or sold
facilitate transfers of funds

from a person or business
without investment
opportunities to those who
have them
Financial markets
Securities
claims on an issuers debt (bonds)
claims on an issuers equity (stocks)
Financial markets
The role of financial markets
Surplus units
participants who receive more money than they spend (such as
investors); also known as lender-savers
Deficit units
participants who spend more money than they receive (such as
borrowers); also known as borrower-spenders
Direct Financing
Funds transferred directly from ultimate savers (surplus units)
to ultimate borrowers (deficit units)
Indirect Financing
Funds transferred from surplus units to deficit units through a
financial intermediary
The intermediary transforms financial claims with one set of
characteristics into financial claims with other characteristics (for
example, deposits are used to make loans)
The role of the financial system
The role of the financial system (financial

markets and institutions)
To facilitate the flow and efficient allocation of funds
throughout the economy
An efficient and sound financial system is a necessary
condition to having a highly advanced economy
Types of financial markets
Based on maturity structure

Money markets
Capital markets
Based on trading structure

Primary markets
Secondary markets
Money markets
Facilitate the flow of short-term funds
Institutions involved include banks, non-bank financial
institutions and primary dealers
Capital markets
Facilitate the flow of long-term funds
Institutions involved include stock exchanges, investment
banks, credit rating companies and so on.
Primary markets
Facilitate the issuance of new securities
For example: the sale of new corporate stock or new Treasury
securities
Secondary markets
Facilitate the trading of existing securities
For example: the sale of existing stock
How financial markets facilitate corporate finance

Financial markets attract funds from investors.
These funds are channeled to investors.
Money markets enable corporations to borrow funds on a
short-term basis to finance existing operations.
Capital markets enable corporation to obtain long-term
financing to support business expansion.
Types of securities
Money market securities

Debt securities with a maturity of one year or less
Liquid; low expected return; low degree of risk
Examples: treasury bills (government), commercial paper
(corporations), negotiable certificates of deposit (depository
institutions)
Types of securities
Capital market securities

Debt or equity securities with a maturity of more than one year
Higher expected return; more risk involved
Examples: stock (corporations), bonds (corporations,
government), mortgages (households)
Types of securities
Derivative securities
Financial contracts whose values are derived from the value of
the underlying assets (such as debt or equity securities)
Traded in financial markets
Used for speculation and risk management
Examples: options, futures
Futures
A buyer and a seller agree to a specific price or quantity
exchange some time in the future
For example, you agree to buy a 2,250 taka share of BATBD for
2,500 taka in a year
Futures
If the price of a BATBC share is 3,500 taka in a year, you can
buy the share for 2,500 taka, turn around and sell it for the
market price of 3,500 taka and make a nifty profit
If the price of a BATBC share is 2,000 Taka in a year, you have to
buy the share for 2,500 taka and you incur a paper loss of 500
taka
Options
A financial derivative that represents a contract which offers the
buyer the right, but not the obligation, to buy or sell a security or
other financial asset at an agreed-upon price during a certain
period of time or on a specific date
For example, you pay 50 taka to get the option to buy a share of
BATBD for 2,250 taka in a year
Options
If the price of a BATBC share is 3,000 taka in a year, you can
buy the share for 2,250 taka, turn around and sell it for the
market price of 3,000 taka and make a nifty profit
If the price of a BATBC share is 2,000 Taka in a year, you can
simply walk away. All you lose is that 50 taka premium.
Role of financial institutions
Depository institutions
Accept deposits from surplus units and provide credit to deficit
units
Are popular because
deposits are liquid
loans are customized
they accept the risk of loans
they have expertise in evaluating creditworthiness
they diversify their loans
Examples: commercial banks
Commercial banks
Are the most dominant depository institution
Offer a wide variety of deposit accounts
Transfer deposited funds by providing direct loans or
purchasing debt securities
Serve both the public and the private sector
Examples: Sonali Bank, Prime Bank
Non-depository institutions
Generate funds from sources other than deposits
Play a major role in financial intermediation
Examples: finance companies, mutual funds
Finance companies
Obtain funds by issuing securities, taking bank loans, issuing
commercial paper, etc.
Lend funds to individuals and businesses
Examples: IDLC, IPDC
Mutual funds
Sell shares to surplus units
Use funds to purchase a portfolio of securities
Run by asset management companies, such as ICB
Securities firms
Serve as brokers by executing securities transactions between
two parties, as dealers by making a market in a specific security
or as investment bankers by underwriting newly issued
securities
Examples: LankaBangla Finance, Prime Finance and
Investment, BRAC EPL
Insurance companies
Provide insurance policies to individuals and firms for death,
illness, and damage to property
Charge premiums
Invest in stocks or bonds issued by corporations
Examples: Jiban Bima Corporation (life insurance), Sadharan
Bima Corporation (general insurance)
Comparison of role
Institutional uses and sources of funds
Chapter 2
Determination of interest rates
Loanable funds theory

Commonly used to explain interest rate movements.
Suggests that market interest rate is determined by factors
controlling the supply of and demand for loanable funds.
Particularly useful for explaining movements in the general
interest rates for a particular country.
Also useful for explaining why interest rates among debt
securities of a given country vary (chapter 3).
Determination of interest rates
Demand for loanable funds

Household demand for loanable funds
Business demand for loanable funds
Government demand for loanable funds
Foreign demand for loanable funds
Aggregate demand for loanable funds

Households demand loanable funds to finance
Housing expenditures
Automobiles
Household items
Inverse relationship between the interest rate and the quantity
of loanable funds demanded.


Businesses demand loanable funds to invest in fixed assets and
short-term assets
Depends on number of business projects to be implemented.
More demand at lower interest rates.
There is an inverse relationship between interest rates and
business demand for loanable funds

Government demand for loanable funds

Governments demand funds when planned expenditures are
not covered by incoming revenues
Interest inelastic: insensitive to interest rates. Expenditures and
tax policies are independent of the level of interest rates
Impact of increased government deficit on the government

demand for loanable funds

A countrys demand for foreign funds depends on the interest
rate differential between the two.
The greater the differential, the greater the demand for foreign
funds.
The quantity of U.S. loanable funds demanded by foreign
governments will be inversely related to U.S. interest rates.

Interest rate
Df
Quantity of loanable funds


The sum of the quantities demanded by the separate sectors at
any given interest rate is the aggregate demand for loanable
funds
Supply of loanable funds
Households are largest supplier, but some supplied by

government units.
More supply at higher interest rates.
Supply by buying securities.
Effects of the central bank: By affecting the supply of loanable
funds, the central banks monetary policy affects interest rates.
Aggregate supply of funds
Aggregate supply of loanable funds
Equilibrium interest rate
Aggregate Demand for funds (DA)

DA = Dh + Db + Dg + Dm + Df
Dh = household demand for loanable funds
Db = business demand for loanable funds
Dg = federal government demand for loanable funds
Dm = municipal government demand for loanable funds
Df = foreign demand for loanable funds
Aggregate Supply of funds (SA)

SA = Sh + Sb + Sg + Sm + Sf
Sh = household supply for loanable funds
Sb = business supply for loanable funds
Sg = federal government supply for loanable funds
Sm = municipal government supply for loanable funds
Sf = foreign supply for loanable funds
SA
Interest rate
DA

Factors that affect interest rate
Economic growth
Inflation
Monetary policy
Budget deficit
Foreign flows of funds
Impact of economic growth on interest rates

Puts upward pressure on interest rates by shifting demand for
loanable funds.
Shifts the demand schedule outward (to the right).
There is no obvious impact on the supply schedule.
Supply could increase if income increases as a result of the
expansion.
The combined effect is an increase in the equilibrium interest
rate.
Impact of economic growth on interest rates

SA
Interest rate
i2
i1
DA2
DA1

Impact of economic slowdown on interest rates
SA
Interest rate
i1
i2
DA1
DA2

Impact of inflation on interest rates

Puts upward pressure on interest rates by shifting supply of
funds inward and demand for funds outward.
Inward shift of supply curve: households increase consumption
now if inflation is expected to increase
Outward shift of demand curve: households and businesses
borrow more to purchase products before prices rise
Fisher effect:
i = E(INF) + iR
where i = nominal or quoted rate of interest
E(INF) = expected inflation rate
iR = real interest rate
Impact of inflation on interest rates

SA2
SA
i2
Interest rate
i1
DA2
DA1

Impact of monetary policy on interest rates

If the central bank increases the money supply, the supply of
loanable funds increases
When the central bank reduces the money supply, it reduces
the supply of loanable funds, putting upward pressure on
interest rates.
Impact of budget deficit on interest rates

Crowding-out Effect: Given a certain amount of loanable
funds supplied to the market, excessive government demand for
funds tends to crowd out the private demand for funds.
Impact of foreign flow of funds on interest rates

Interest rate for a certain currency is determined by the demand
for funds in that currency and the supply of funds available in
that currency.
Forecasting interest rates
Net Demand (ND) should be forecast: ND = DA SA
Future demand for loanable funds depends on future

Foreign demand for funds
Household demand for funds
Business demand for funds
Government demand for funds
Future supply of loanable funds depends on future
Supply by households, businesses and government
Foreign supply of loanable funds
Chapter 4
4. Functions of the Fed
Overview
The central bank

The central bank of a country
acts as the governments banker and the bankers bank
implements monetary policies
controls the countrys money supply
determines interest rates
manages the countrys foreign exchange reserves
regulates and supervises the banking industry
List of central banks
The central bank

A list of countries and their central banks:
USA: the Federal Reserve System (or the Fed)
EU: European Central Bank
UK: Bank of England
Canada: Bank of Canada
India: Reserve Bank of India
Australia: Reserve Bank of Australia
China: Peoples Bank of China
Central bank leaders
USA: Federal Reserve

Chair: Dr. Janet Yellen
Feb. 2014 present
B.A., Brown University
Ph.D., Yale University
Married to George Akerlof,
Nobel Prize winner in
economics in 2001.

Dr. Ben Bernanke
Chair, 2006 2014
A.B., A. M., Harvard
University
Ph.D., M.I.T.

Dr. Alan Greenspan
Chair, 1987 2006
B.S., M. A., Ph.D., New
York University
European Central Bank

Dr. Mario Draghi
President, 2011
Present
Ph.D., M.I.T.
Bank of England
Dr. Mark Carney
Governor, 2013
Present
B.A., Harvard.
M.Phil., D.Phil.,
Oxford.
13 years in Goldman
Sachs
Governor, Bank of
Canada (2008 2013)
Reserve Bank of India

Dr. Raghuram Rajan
Governor, 2013
Present
Ph.D., M.I.T.
Bangladesh Bank
Dr. Salehuddin Ahmed
Governor, 2005 2009
B.A., M. A., Dhaka
University
M.A., Ph.D., McMaster
University
Bangladesh Bank
Dr. Atiur Rahman
Governor, 2009 March
2016
B.A., M. A., Dhaka
University
M.A., Ph.D., SOAS
Bangladesh Bank
Mr. Fazle Kabir
Governor, March 2016
Present
B.A., M. A., University
of Chittagong
Former senior secretary,
Ministry of Finance
Former Chairman,
Sonali Bank
Organizational structure of the Fed
The Fed
The Fed has five major components
Federal Reserve district banks (map, page 79)
Member banks
Board of Governors
Federal Open Market Committee (FOMC)
Advisory Committees
Federal Reserve district banks

Twelve district banks: Boston, New York,
Philadelphia, Cleveland, Richmond, Atlanta, Chicago,
St. Louis, Minneapolis, Kansas City, Dallas and San
Francisco
The most important bank: New York
Commercial banks can become members of the Fed by
buying stock in their district bank.
This stock cannot be traded in a secondary market.
Maximum dividend = 6% annually
Federal Reserve district banks

Each district bank has nine directors:
three class A directors representatives of banks
three class B directors public voted in by the banks
three class C directors appointed by the Board of Governors
Class B and class C directors appoint the President of
the district banks.
Fed district banks clear checks, replace old currency
and provide loans to depository institutions in need.
Fed district banks collect data and conduct research
projects.
Member banks
Commercial banks can become member banks of the
Fed by buying stock of the Fed district bank.
Elect six of nine directors in the district bank.
35% of American banks are members of the Fed
Board of Governors
Seven members appointed by the U.S. President for
14-year terms (non-renewable)
One of the members chosen as the Chair of the Federal
Reserve for a four-year term (renewable)
Sets credit controls (margin requirements).
Has the power to revise reserve requirements
Participates in the FOMC decisions to control money
supply.
Federal Open Market Committee

Seven BoG members plus 5 Fed district bank
Presidents
The Chair of the BoG is also the Chair of the FOMC
Main goals include stable economic growth with low
inflation by controlling money supply.
Advisory Committees
Federal Advisory Council
Consumer Advisory Council
Thrift Institutions Advisory Council
Federal Advisory Council

Consists of one member from the banking industry of
each Federal Reserve district
Each district member elected each year by the board of
directors of the district banks
The Council makes recommendations about economic
and banking policy to the Board of Governors
Consumer Advisory Council

Made up of 30 members from the financial industry
and its consumers
The Council discusses consumer issues with the Board
of Governors
Thrift Institutions Advisory Council

Made up of 12 members from the thrift institutions
(savings banks, savings and loans associations, and
credit unions)
The Council discusses issues related to thrift
institutions with the Board of Governors
How the Fed controls money supply
The Fed
The Fed controls money supply to affect interest rates.
Open market operations
Role of the Feds Trading Desk
Adjusting the Reserve Requirement Ratio
Adjusting the Feds Loan Rate
Federal Open Market Committee

Meets eight times a year.
Targets for the money supply growth level and the
interest rate level determined
Actions taken to implement monetary policy dictated
by the FOMC
Pre-Meeting Economic Reports

The Beige book sent to FOMC members two weeks
before the FOMC meeting
A consolidated report of economic conditions in each
of the 12 districts
Analyses of the economy and economic forecasts sent
to FOMC members one week before the meeting
Economic Presentations
Presentations by staff members (usually economists)
to the Board of Governors and districts bank presidents
Include data and trends for wages, consumer prices,
unemployment, GDP, business inventories, forex rates,
interest rates and financial market conditions
Assessment conducted to predict economic growth
and inflation
Much attention paid to factors (such as oil prices) that
can affect inflation
FOMC decisions
FOMC members make recommendations about the
federal funds rate
A weakening economy might lead to
recommendations to lower federal funds rate to
stimulate the economy
In December 2008, federal funds rate lowered to 0.00
0.25%
FOMC statement
FOMC statement summarizing the recommendations
provided at the end of the FOMC meeting
Clearly written statement with meaningful details
Made publicly available on the Federal Reserves
website
Click here for the latest FOMC statement from the Feds website.
Role of the Feds trading desk

FOMC decisions forwarded to the Trading Desk (or
Open Market Desk) in a policy directive
Traders instructed to buy or sell government securities
(known as open market operations)
Fed Purchase of Securities

Traders at the Trading Desk purchase Treasury
securities to lower federal funds rate.
Fed purchase of treasury securities through securities
dealers increases the bank account balances of the
dealers and the total deposit in the banking system.
This increase in the supply of funds places downward
pressure on federal funds rate.
Such activity represents a loosening of money supply
growth.
Fed Sale of Securities

Traders at the Trading Desk sell Treasury securities to
increase federal funds rate.
Fed sale of treasury securities through securities
dealers decreases the bank account balances of the
dealers and the total deposit in the banking system.
This decrease in the supply of funds places upward
pressure on federal funds rate.
Such activity represents a tightening of money supply
growth.
Fed Trading of Repos

Traders at the Trading Desk buy repurchase
agreements to increase bank funds for a few days to
ensure liquidity in the banking system for those days.
The level of funds rises initially for a few days as the
Fed buys Treasury securities and then falls as the Fed
sells the Treasury securities back after a few days.
This is done during holidays to correct temporary
imbalances.
How the Fed Operations Affect All Interest Rates

The use of open market operations to increase bank
funds can affect all interest rates.
The federal funds rate may decline because banks may
have a larger supply of excess funds to lend out in the
federal funds market.
Banks with excess funds may offer new loans at a
lower interest rate to make use of these funds.
These banks may lower interest rates on deposits
because they have excess liquidity.
How the Fed Operations Affect All Interest Rates

When the Fed buy Treasury bills, it places upward
pressure on the prices of T-bills.
Higher prices translate to lower yields for T-bills.
Bank rates are also lowered, as previously discussed.
Investors search for alternative investments.
As more funds are invested in alternative securities,
their yields decline.
The reduction in yields lowers the cost of borrowing.
This encourages potential borrowers to borrow and
spend.

Depository institutions (e.g. banks) must keep a
portion of their reserves with the central bank.
Also called cash reserve ratio (CRR)
A monetary policy tool because money supply can be
affected by changing CRR
A lower CRR increases the proportion of a banks
deposits that can be lent out.
As the funds loaned out are spent, a portion of these
loans come back in the form of new deposits.
The lower the CRR, the greater is the lending capacity
of depository institutions.

For a better understanding of how CRR works, read
the Example from Page 87 of your textbook.
Click here to read an article from the Daily Star (June 24, 2014)
about Bangladesh Bank raising CRR.
Bangladesh Bank
Structure
The government owns 100% of the shares.
Four-year appointment for the governor, renewable
until retirement age.
Three deputy governors:
Abu Hena Mohd. Razee Hassan, Shitangshu Kumar Sur
Chowdhury, S. M. Moniruzzaman
Click here to read the latest monetary policy statement from the
Bangladesh Bank.
Chapter 6

Debt securities with maturities of one year or less
Treasury bills
Commercial paper
Negotiable certificates of deposit
Repurchase agreement
Federal funds
Bankers acceptances
Treasury bills
Government debt securities with maturities of less than one year
Currently, only treasury bills of three different maturities are
auctioned by the Bangladesh Bank: 91-day, 182-day and 364-day
The US Treasury issues 4-week, 13-week, 26-week and 52-week
maturities.
T-bills used to be issued in paper form, but now, they are
maintained electronically.
Treasury bills
T-bills are issued at BDT 100,000 or multiples of 100,000 in
Bangladesh, and $100 or multiples of $100 in USA.
T-bills are sold at a discount. The gain to an investor holding a
T-bill until maturity is the difference between par value and the
price paid.
Treasury bills
T-bills are attractive investments because they are backed by
the government and are virtually free of default (credit) risk.
They are attractive investments also because of their liquidity,
which is due to their short maturity.
Treasury bills
T-bills are sold through auctions.
If an investor wants to buy T-bills in an auction, they have to do
so through a primary dealer (PD), because only primary dealers
are allowed to bid in T-bill auctions.
T-bills can also be purchased in the secondary market, from
PDs, other banks and financial institutions.
Commercial paper
Commercial papers are short-term debt instruments issued by
well-known, credit-worthy firms, and are typically unsecured.
A commercial paper is issued to provide liquidity or to finance
a firms investments in inventory and accounts receivable.
The minimum denomination of commercial paper is $100,000.
Read two articles from the Daily Star about commercial

papers in Bangladesh. Article 1 Article 2
Commercial paper
Maturities of commercial paper are between 1 day and 270
days, by law, but generally, between 20 days and 45 days.
There are very few individual investors due to the high
denomination; mostly institutional investors purchase
commercial paper.
Most investors hold on to these instruments until maturity.
Commercial paper
A commercial papers default risk is dependent on the issuers
default risk.
The rating is done by credit rating companies (such as Moodys
or S&P).
Corporations can issue placement of commercial paper more
easily if the rating is high.
Some commercial paper (called junk commercial paper) is rated
low or not rated at all.
Commercial paper
Some firms place commercial paper directly with investors.
Other firms rely on commercial paper dealers to sell their
commercial paper at a transaction cost of about one-eighth of one
percent of the face value.
Commercial paper
Some commercial paper is backed by assets of the issuer
(secured) and hence, should offer lower yield than unsecured
commercial paper, but in reality, its the opposite.
Why? Because firms that issue secured or asset-backed
commercial paper have more default risk than the firms who can
issue unsecured commercial paper, and the value of assets used
as collateral may be questionable.
Commercial paper
The yield curve for commercial paper is established for a
maturity of 0 to 90 days.
The shape of the yield curve can be derived from the short-term
yield curve of treasury bills.
The same factors that affect treasury yield curves affect the
yield curves for commercial paper.
In particular, expectations regarding the interest rate over the
next few months can influence the commercial paper yield curve.

NCDs are certificates issued by large commercial banks and
other depository institutions as a short-term source of funds.
The minimum denomination is $100,000, although a $1 million
denomination is more common.
Nonfinancial corporations usually purchase NCDs.

Maturities range from two weeks to one year, and there is an
active secondary market for NCDs.
Placement is usually done directly, while some NCDs are sold
through a correspondent institution that specializes in placement
and some through securities dealers.
NCDs must offer a premium over T-bills to compensate
investors for less liquidity and safety.

In the US, 6-month CD rates currently vary between 0.85% and
1.36%, with the national average being 1.19% (according to
bankrate.com).
Repurchase agreements
With a repo, one party sells securities to another with an
agreement to buy back the securities at a specified date and price.
In essence, the repo transaction is a loan backed by securities.
A reverse-repo is the same transaction viewed from the buyers
perspective.
Repurchase agreements
Financial institutions such as banks and money market funds
participate in repos.
Maturities range from 1 day to 15 days, and 1, 3 and 6 months.
There is no secondary market for repos.
Placement is done over a telecommunications network. Dealers
and repo brokers help to create repos.
Federal funds
The federal funds market enables depository institutions to
borrow from each other at the federal funds rate.
This rate is determined by demand for and supply of funds in
the federal funds market.
The federal funds rate is slightly higher than the T-bill rate.
Federal funds
Maturities range from 1 day to 7 days.
Most transactions are for $5 million or more.
Commercial banks and NBFIs are the most active participants
and federal funds brokers serve as financial intermediaries when
needed.
Federal funds
The rate is known as the federal funds rate or the call money
rate.
The weighted-average call money rate in Bangladesh went
from 4.39% in 2009 to 8.06% in 2010 to 11.16% in 2011 to 12.82%
in 2012. It has stabilized since then.
The weighted-average call money rate in Bangladesh has
stayed within the comparatively narrow band of 5.63% to 8.57%
since the beginning of 2014.
Federal funds
Weighted-average call money rate
14
12
10
0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Bankers acceptance
A bankers acceptance indicates that a bank accepts
responsibility for a future payment, usually for international
trade transactions.
The importer will pay the bank the amount owed to the
exporter, plus a fee for the bank guarantee.
Exporters can hold the bankers acceptance until maturity, or
sell them at a discount to obtain cash immediately.
Bankers acceptance
The investor receives cash directly from the bank.
Maturities range from 30 to 270 days.
The yield is higher than that of T-bills.
There is an active secondary market. Dealers facilitate trading
of these instruments in the secondary market.
Bankers acceptance
There are seven steps involved in bankers acceptances.
The importer places a purchase order for the goods.
The importer asks the bank to issue an L/C on its behalf.
The L/C is presented to the exporters bank.
The exporters bank informs the exporter that the L/C has been
received.
Bankers acceptance
The exporter ships the goods to the importer.
The exporter sends the shipping documents to its bank.
The exporters bank passes the shipping documents to the
importers bank, and the B/A is created, which obligates the
importers bank to make payment to the holder of the B/A at a
specified future date.
Chapter 7
Bond markets
Bonds
Bonds are long-term debt securities issued by
government agencies or corporations.
The issuer is obligated to pay interest (or coupon)
payments periodically and the par value (or principal) at
maturity.
Most bonds have maturities between 10 and 30 years.
Bond markets
Bonds
Bonds are issued in the primary market and then traded
in the secondary market.
They are issued to finance deficit spending by
governments and operations expansion by corporations.
Bond markets finance economic growth by allowing
households, corporations and the government to increase
their expenditure.
Bond markets
Bond yields
Bond yields are determined by current market rates and
risk.
The yields are usually fixed throughout the term of the
bond.
Bond markets
Bond yields
The yield-to-maturity is the issuers cost of financing and
reflects the annualized yield paid by the issuer over the life
of the bond.
Investors look at their holding period return, rather than
yield-to-maturity since many of them do not hold bonds to
maturity.
Bond markets
Bond classification (by issuers)
Issuer Type of Bond

Federal Government Treasury Bonds
(U.S. Treasury)
Federal Agencies Federal Agency Bonds
State and Local Municipal Bonds
Governments
Corporations Corporate Bonds
Bond markets
U.S. Treasury Bonds

U.S. Treasury bonds are issued by the U.S. Treasury
Department to finance federal government expenditures.
Treasury Notes have maturities of less than 10 years, and
Treasury bonds have maturities of between 10 and 30 years.
Bond markets
U.S. Treasury Bonds

There is an active secondary market for U.S. Treasury
Bonds.
U.S. Treasury bonds pay semiannual coupon payments.
These instruments serve as the benchmark debt security
for any maturity.
Bond markets
Treasury Bonds in Bangladesh

The Bangladesh Bank issues Treasury bonds in
Bangladesh.
Currently, the Bangladesh Bank sells two, five, ten, fifteen
and twenty year treasury bonds.
The central bank holds auctions every week and any
investor can bid for bonds through any bank.
An auction committee fixes the coupon rate which is
applicable throughout the instruments life.
Bond markets

Treasury bonds pay interest or coupon payments every
six months.
Generally, these bonds are of 100,000 Taka denomination
or their multiples.
Rates range from 5.50% for 2-year bonds to 8.99% for 20-
year bonds.
Bond markets

Bond markets
Stripped Treasury bonds

STRIPS (Separate Trading of Registered Interest and
Principal of Securities) are zero-coupon, fixed-income
securities issued by FIs (financial institutions).
They are sold at a significant discount to face value and
offer no interest payments because they mature at par.
Bond markets
Stripped Treasury bonds

Financial institutions transform the cash flows of
Treasury bonds into separate securities.
The principal payment is separated from the coupon
payments, and each of the coupon payments is turned into
an individual zero-coupon security.
The principal payment is also transformed into a zero-
coupon security.
These stripped Treasury bonds are called STRIPS.
Bond markets
Inflation-indexed Treasury bonds

The Treasury issues bonds that provide returns tied to the
inflation rate.
These bonds ensure that the returns on investment keep
up with the inflation rate (CPI or consumer price index).
Inflation-indexed Treasury bonds are known as:
TIPS (Treasury Inflation-Protected Securities) in USA
GILTS in the UK
Bond markets
Savings bonds
The Treasury issues these debt instruments that can be
purchased by ordinary investors from
www.treasurydirect.gov for as little as $25.
These bonds have a 30-year maturity.
The interest is compounded semiannually and is paid off
at maturity with face value.
Bond markets
Savings certificate
The Directorate of National Savings (under the Ministry
of Finance) in Bangladesh issues savings certificates
(Sanchaypatra) that can be purchased by ordinary investors
from the post office or from branches of FIs for as little as
BDT 10.
These certificates have various maturities.
Bond markets
Savings certificate
There are several types of savings certificates.
5-year family savings certificates
Pensioners certificate
Postal savings and bank certificates
3-year savings certificates with quarterly returns
The rates for savings certificates were revised
downwards in May 2015 to reduce the governments debt
burden.
Bond markets
Municipal bonds
These bonds represent state and local government debt
obligations and are issued to finance deficit spending.
There are no munis (or municipal bonds) in Bangladesh.
They are, however, very important in a global context.
Bond markets
Municipal bonds
General obligation bonds are debt securities whose
payments are supported by the local governments ability
to tax.
Revenue bonds are debt securities which are financed by
revenues generated by a project (toll on a bridge, toll on an
elevated express way, etc.)
Bond markets
Corporate bonds
Corporate bonds are long-term debt securities issued by
corporations.
These bonds usually pay semi-annual coupon payments
and the principal at maturity.
Bond markets
Corporate bonds
Corporate bonds usually have maturities ranging
between 10 to 30 years.
Corporate bonds can be sold in the primary market
through a public offering or a private placement.
Bond markets
Characteristics of corporate bonds

Bond indenture: Legal document specifying rights and
obligations of issuer and bondholder
Sinking-fund provision: Requirement that the firm retire
a certain amount or number of bonds each year to protect
investors with principal reduction
Bond markets

Protective covenants: Place restrictions, such as amount
of dividends, amount of additional debt to be issued and
corporate officers salaries, on the firm to protect
bondholders.
Call provisions: Ability to pay bonds off early.
Debentures: Unsecured bonds.
Bond markets

Zero-coupon bonds: Bonds that pay zero coupon
payments and are issued at a deep discount.
Variable-rate bonds: Also known as floating-rate bonds.
Their coupon rates are pegged to the LIBOR.
Bond markets

Convertible bonds: Bonds that can be converted into
shares of common stock of the company.
Junk bonds: Corporate bonds with very high default risk.
Bond markets
Bond markets in Bangladesh

Read this 2011 article stressing the need for a strong
domestic bond market in Bangladesh.
The Bangladesh Bank Governor urged foreign banks to
help build a strong bond market in Bangladesh.
Read this 2015 article about how the Bangladesh

government plans to boost the domestic bond market.
The government withdrew source tax on interest income
of T-bonds and T-bills, as per this article.

FIN 433 - Exam 1 Slides

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FIN 433 - Exam 1 Slides

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Chapter 1 Financial markets and institutions

Chapter 2 Interest rates

Chapter 4 Central bank

Chapter 6 Money market

Chapter 7 Bond market

facilitate transfers of funds

The role of the financial system (financial

Based on maturity structure

Based on trading structure

How financial markets facilitate corporate finance

Money market securities

Capital market securities

Loanable funds theory

Demand for loanable funds

Household demand for loanable funds

Household demand for loanable funds

Business demand for loanable funds

Business demand for loanable funds

Government demand for loanable funds

Impact of increased government deficit on the government

Foreign demand for loanable funds

Foreign demand for loanable funds

Quantity of loanable funds

Aggregate demand for loanable funds

Households are largest supplier, but some supplied by

Aggregate Demand for funds (DA)

Aggregate Supply of funds (SA)

Quantity of loanable funds

Impact of economic growth on interest rates

Impact of economic growth on interest rates

Quantity of loanable funds

Impact of economic slowdown on interest rates

Quantity of loanable funds

Impact of inflation on interest rates

Impact of inflation on interest rates

Quantity of loanable funds

Impact of monetary policy on interest rates

Impact of budget deficit on interest rates

Impact of foreign flow of funds on interest rates

Net Demand (ND) should be forecast: ND = DA SA

Future demand for loanable funds depends on future

The central bank

The central bank

USA: Federal Reserve

USA: Federal Reserve

USA: Federal Reserve

European Central Bank

Reserve Bank of India

Federal Reserve district banks

Federal Reserve district banks

Federal Open Market Committee

Federal Advisory Council

Consumer Advisory Council

Thrift Institutions Advisory Council

Federal Open Market Committee

Pre-Meeting Economic Reports

Role of the Feds trading desk

Fed Purchase of Securities

Fed Sale of Securities

Fed Trading of Repos

How the Fed Operations Affect All Interest Rates

How the Fed Operations Affect All Interest Rates

Adjusting the Reserve Requirement Ratio