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Lecture Money and capital markets: Chapter 9 – Peter S. Rose, Milton H.Marquis

In this chapter, students will be able to understand: Derivatives transfer risk from one person or firm to another; futures contracts are standardized contracts for the delivery of a specified quantity of a commodity or financial instrument on a prearranged future date, at an agreed-upon price; options give the buyer (option holder) a right and the seller (option writer) an obligation to buy or sell an underlying asset at a predetermined price on or before a fixed future date;. | Chapter 9 Interest Rate Forecasting & Hedging: Swaps, Financial Futures, & Options Learning Objectives To understand why financial analysts today usually choose hedging (protecting) against losses from changing interest rates and asset prices rather than attempting to forecast interest rates or the prices of financial assets. To examine several popular hedging tools, including interest rate swaps, financial futures, and option contracts. Introduction For actively traded assets, demand and supply forces are continually shifting, such that investors interested in these assets must constantly stay abreast of the latest developments. It is thus no wonder that accurate interest-rate and asset-price forecasting is so difficult, if not impossible. Interest-Rate and Asset-Price Forecasting If interest rates can be forecasted accurately, borrowers can borrow when rates are supposed to be the lowest, while lenders can target the expansion of their lending programs to those periods when . | Chapter 9 Interest Rate Forecasting & Hedging: Swaps, Financial Futures, & Options Learning Objectives To understand why financial analysts today usually choose hedging (protecting) against losses from changing interest rates and asset prices rather than attempting to forecast interest rates or the prices of financial assets. To examine several popular hedging tools, including interest rate swaps, financial futures, and option contracts. Introduction For actively traded assets, demand and supply forces are continually shifting, such that investors interested in these assets must constantly stay abreast of the latest developments. It is thus no wonder that accurate interest-rate and asset-price forecasting is so difficult, if not impossible. Interest-Rate and Asset-Price Forecasting If interest rates can be forecasted accurately, borrowers can borrow when rates are supposed to be the lowest, while lenders can target the expansion of their lending programs to those periods when interest rates are expected to be the highest. Unfortunately, forecasting interest rates is far from easy, and may be virtually impossible. Interest-Rate and Asset-Price Forecasting There are, however, a few predictable aspects to interest-rate and asset-price movements. To understand these few regularities and how the financial markets account for them can significantly reduce the exposure of one’s investments to interest-rate and price movements and minimize market risk. Interest-Rate and Asset-Price Forecasting Interest rates tend to fall (and debt security prices rise) during a business recession, and rise (and debt security prices fall) during an economic expansion. These phases of the business cycle may last months or years. Interest-Rate and Asset-Price Forecasting In general, short-term interest rates tend to be more sensitive to business cycle changes than long-term interest rates on bonds and other capital market securities. On the other hand, long-term asset prices tend to be .