Asset Markets ( Burda + Wyplosz) rynki aktywow Tobin q (value on the market/ company recorded assets)( wartosc na rynku/

rzeczywista wartosc) prices determined on financial markets financial markets influence macroeconomy: infleunce spending , cost of borrowing and I, the exchange rates ( in the heart of international trade and financial flows) determine the value of assets ( various forms in which wealth is held) asset markets different from good markets: impersonal and prices exhibit a high degree of volatility: seem to depend on the whim of investors and speculators (casino-like) => really more complex assets: durable ( not consummed, but for later disposal)=> driven entirely by the future ( prices) future incertain= assets risky assets=> tend to be traded in large markets How asset markets work? Eg: stock markets, money markets, bond markets, commodity, foreign exchange, derivative... durable ( not perishable) + negligeable storage cost=> natural vehicle for saving for future consumption markets for stock ( and not flows of good and services): each day only a small fraction of existing assets ( in e.g. 1%) is bought/ sold: the rest is held. Exeption: when the participants are concerned/ in panic the assets can be dumped on the marked=> multipling the usual level => explains size and potential volatility: big capitalization affects economy. perfect competition: well organized trading systems dealing with staandardized products: technology, computers: acces and trade at any moment from anywhere in the world if internet and telephone connection. => Inherent potential instability: adaptation of the usual demand/ supply analisis new assets : indistinguishable from old ones: at every moment trading involves both: decision to sell/ buy in large quantity can be made at any moment=> that's why different from good markets ( supply of and demand for must be balanced). Asset markets: prices movements to clear the demand/ supply for the whole stock ( usun to zapotrzebowanie?). Inactivity ( holding what they have) is also a market decision. Result of durabilty: asset markets are forward looking ( decisions driven by expectations of what can happen nect). Future unknown-> so incertainty, paying close attention to other's actions: no one has the whole information, but likely that someone possesses valuable info. Challenge: guessing what others know ( or think they know) and what of that is true. => rumors or expectations can alter demand/ supply in matter of minutes: prices that equate it, can swing widely.=> also art, contracts for deliveries markets: stong ressemblance to markets of financial assets. Functions of asset markets 3 essential economic functions intermediation between borrowers and lenders: most individuals do not deal directly on asset markets ( small quantities, lack of expertise) but by financial intermediaries=> ressemble a whole sale market with professional traders ( accept and execute large orders, average 5 million euros, relatively small fees, for exemple for converting). Finacial intermediaries place orders for several customer at once, or even make a market ( to which they add or sell from) saving: deferred consumption; investement: the creation of physical productive capacity putting a price on the future: setting interest rates= pricing the future ( cupons with bonds, dividend with shares ( akcje)). Interest rates: reflect the overall impatience of borrowers and lenders. But central bank sets the short- term rates. So how...?=> demand and supply of assets reflects the preferences of borrowers and lenders. Interest rates rises as the the

maturity lenghtens: uncertainty rises and impatience: borrower is ready to pay a maturity premium, because the fonds will remain longer at his disposal. => theoric curve, but in reality doesn't conform exacly: in the next years bank will be pushed to change the interst rate ( its expected decision affects the shape of the curve in the first few years): theoretical is based on assumption that the short term rate is kept unchanged by the central bank. Importance of expectations: if the financial market believe that bank will reduce its short term interest rate over the next 2 or 3 years, this will tend to reduce the long term rates at corresponding maturity: curve deoends on the relative strengh of two effets: maturity premium ( always upward) and expectations of rising/ decling short term rates a basic rule of financial markets: obvious profits are quickly eliminated by the markets: no profit rule: equivalent financial operations carry the same interest rate.Prove: If we have return for the long term loan, annual interst iL for L years, then we have total return: (1+ iL)L expected one year interest rate int years is iet, so return from such is: (1+i1) (1+ie2)...(1+iet)...(1+ieL) equals, so long time rate at the time t is equal to the average of expected future short term rates ( possibly plus a risk premium) allocation of risk: asset-holders want to reduce their exposure to risk; different levels of risk aversion: pricing the risk and allocating to thise most willing to bear it: protection against risk through: diversification: ( e.g. With ready made funds, or funds of funds): reducing or even eliminating the risk by risk in different directions: financial markets are best when assets are negatively correlated. If independent: less riskythan no diversification, positively correlated: just as risky. If much risk macroeconomic (buissness cycles, policy actions)=> won't serve much. However foreign assets: likely to have different characteristics=> globalization of financial market price of risk: not possible to eliminate risk entirely=> compensation called risk premium somme e.g.: 50z ( expected value), 48-willing to pay; : risk premium is 4% of the risk free price: not to forget the risk-free rate ( time price) usual mesure of the riskiness of investement is the standard deviation consentration and volume: endless search for diversification risk premium also rises with maturity ( uncertainty grows the further we look into the future)

Asset prices and yields bonds: loans undertaken by large borrowers, bypassing the banks, going strait to the financial markets: traded at a price that ultimately determine their yield ( rate of return on a an asset based on the purchase price of that asset because of impatience ( payments spread over time) and in some case cases risk: rise to discounting ( valuing future goods or money in terms of goods or money today) if no risk, one year bond: P= Value/(1+i) ultimate bond= consol: its maturity infinite: a perpetuity: giving P to borrower and asking infite payments in coupons, with C=iP, and so value , so P=C/i directly realted: higher interest rate: lower price interst i for every year, so bond price have to be adjusted : one year P= Value of the loan / (1+i), two years P=V/(1+i)2 , . we can deduce the i from that. Face value as 100%, so 1

Stock prices (stock/shares=akcje): selling a piece of the firm: even riskier, because paid from profits, after all the costs ( including interests on bonds and loans) dividend: dt dividends paid at the end of period t qt- real share price at the beggining of period t the yield of return is dt /qt If riskless bond with a year yield r alternative:

r = dt /qt + (qt+1 qt)/qt or qt= ( dt + qt+1)/ ( 1+r) => today's price depend entirely on the future but if qt depends on qt+1, then qt+1 depends on qt+2, etc...: So we have: qt= i=0 ( 1/ (1+r))i+1 dt+1: share price is the discounted value of expected future dividends, forever. Shows market value of the company on the basis of what's it is supposed to earn now and in the indefinite future Also explains the sudden variations of the shares' prices.
But also the risk premium noted , so

r + = dt /qt + (qt+1 qt)/qt, and : qt= i=0 ( 1/ (1+r))i+1 dt+1 - /r => the risk premium reduces the share's price
[crisis: securization: lending to many people in different region supposed to be diversification and less risky Financial intermediaires bought from the banks at a higher price and resold making profit ( because were supposed to be less risky than somme of individual loans bo diversification): but declination of house prices, so even if resold,won't get the money back: many big banks lost billions in securities ranked very high: the risk of house prices variation was not considered.]