Financial Market Integration

Presentation byDipl Oec Mevlud Islami

Schumpeter School of Business and EconomicsUniversity of WuppertalGauszligstraszlige 20 42097 Wuppertal

Outline

Financial Market IntegrationStock Market (Integration)

Bond Market (Integration)

2

Stock Market Integration

Financial market integration means that spatially separated financial markets increasingly merge into a single financial market

Reduction of both capital flow barriers and erosion of the home bias effect (partially due to institutional integration) should increasingly lead market participants to consider shares of different countries as substitutes

4

Stock Market Integrationin Eastern Europe

Perfect substitution requires elimination of exchange rate risk

For the Eastern European countries this precondition is not fulfilled Nevertheless trade within the EU member countries has increased tremendously (BORBEacuteLY 2006)

rarr Amplified synchronization of business cycles

rarr Interlinkages of capital markets should also strengthen

Measurement of financial (stock) market integration

rarr Eg correlation ldquobetardquo

5

Stock Market Integrationin Eastern Europe

The Capital Asset Pricing Model

The Capital Asset PricingModel (CAPM)

The market portfolio is central for the CAPM which assumes that the market portfolio lies on the efficient set and that all investors hold the market portfolio in combination with a desired amount of risk free borrowing and lending

(1)pm

fmfp

rrrr σsdot⎥

⎦

⎤⎢⎣

⎡σminus

+=

The Stock Market 7

(2)

(3)

βi (future) beta factor of security i

σiM covariance between the future returns of security i (ri) and the securities of the market (rM)

variance of the future returns of the market

)rr(r)r(E fMifi minusβ+=

2M

iM

m

mii )r(Var

)rr(Covσσ

==β

2Mσ

The Capital Asset PricingModel (CAPM)

The Stock Market 8

The Beta factor measures the market risk (systematic risk) of a security

It is the risk component which cannot be eliminated throughdiversification

The second risk component ndash unsystematic risk (non-market risk) ndashcan be diversified away and it therefore will not be compensated (bythe market)

The Capital Asset PricingModel (CAPM)

The Stock Market 9

The Market Model

The Market ModelThe return on a common stock is assumed to be related to the return on a market index (eg FTSE100) in the following manner

(4)

where riI = return on security i for some given periodrI = return on market index for the same periodαiI = intercept termβiI = slope termεiI = random error term

iIIiIiIi rr ε+β+α=

The Stock Market 11

The International CAPM

International CAPME(ri ndash rh) = γ1Cov(rirw) + γ2Cov(ri ) (1)

ri return on security irw return on world market portfoliorh interest rate on domestic bonds

relative change of exchange rateγ1 and γ2 prices of the respective covariance risks

Problem with (1)γ1 and γ2 must be determined somehow

e

The Stock Market

amp

eamp

13

International CAPMrw and interest rate on foreign bonds are used as benchmarks

E(rw ndash rh) == (2)

+ rf ndash rh == (3)

+ rf expected return on foreign bonds (denominated in domesticcurrency)

The Stock Market

)eCov(rγ)rCov(rγ w2

ww1 amp+

)(eE amp)(eE amp

)e(ampE )eeCov(γ)reCov(γ 2w

1 ampampamp +)eVar(γ)reCov(γ 2

w1 ampamp +

)eCov(rγ)Var(rγ w2

w1 amp+

)e(ampE

14

International CAPMAssumptionfrom (2) and (3) resultrarr

(4)

(5)

(4) and (5) in (1)

The Stock Market

0)reCov( w =amp

)Var(rr)E(rγ w

hw

1minus

=

)eVar(rr)eE(γ

hf

2 ampamp minus+

=

15

International CAPM

(6)

β1 and β2 (sensitivity measures ) can be estimated as follows

ut ~ (0 σ2)

The Stock Market

)eCov(r)eVar(

)rreE()rCov(r)Var(r)rE(r)rE(r i

hfw

iw

hwh

i ampamp

ampsdot

minus++sdot

minus=minus

)rreE()eVar(

)eCov(r)rE(r)Var(r

)rCov(r hfihww

wi minus+sdot+minussdot= amp

ampamp

)rreE(β)rE(rβ hf2i

hw1i minus+sdot+minussdot= amp

t2iw1ii ueβrβαr +sdot+sdot+= amp

16

Technique employedCointegration Approach

SPit = α + βDAXt + ut (requirement α=0 β=1)

Eight Eastern European countries are considered ie Poland Czech Republic Slovenia and Hungary Estonia Lithuania Latvia and the Slovak Republic

The benchmark market is the German stock market (DAX is used as a proxy)

Monthly data are used covering the period from March 1995 to August 2008 except for Estonia (with the starting point August 1996) Lithuania (with the starting point February 2000) and Latvia (with the starting point March 2000)

17

Stock Market Integrationin Eastern Europe

The Stock Market

18

Stock Market Integrationin Eastern Europe

ytt00t zxbay ++=

xtt11t zybax ++=

(1)

(2)

yt

yn

1jjtyj

xn

1jjtxj

y1-tz

1t001tyy0t uyaxa)xbay(y +sum Δ+sum Δ+minusminusγminusγ=Δ

=minus

=minus

=

minusminus 444 3444 21

xt

n

1jjtyj

n

1jjtxj

z

1t001txx0t uΔybΔxb)xba(yγγΔx

yx

y1t

+++minusminus+= sumsum=

minus=

minus

=

minusminus

minus

444 3444 21

(3)

(4)

Cointegration Approach

The Stock Market

(5)

(6)

(trace-test)

tptp2t21t1t UYAYAYAY

19

Stock Market Integrationin Eastern Europe

++++= minusminusminus

t1pt

1p2t

21t

11tt UYAYAYAYY +Δ++Δ+Δ+Πminus=Δ +minusminusminusminusminus

summinus=Π=

p

1jjAI

1p 2 1j AAp

1jii

j minus=summinus=

+=

sum λminus=+=

k

1rii )ˆ1ln()r(Tr

The Stock Market

20

Stock Market Integrationin Eastern Europe

Series Germany-Czech Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 631767 154947 06580 At most 1 06407 38415 04235 Series Germany-Estonia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 143109 154947 00748 At most 1 31338 38415 00767 Series Germany-Hungary Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 169329 154947 00302 At most 1 28928 38415 00890 Series Germany-Latvia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 163184 154947 00375 At most 1 57756 38415 00162

The Stock Market

21

Stock Market Integrationin Eastern Europe

Series Germany-Lithuania Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 167550 154947 00322 At most 1 47125 38415 00299 Series Germany-Poland Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 118812 154947 01627 At most 1 25319 38415 01116 Series Germany-Slovak Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 64957 154947 06369 At most 1 00518 38415 08200 Series Germany-Slovenia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 42741 154947 08802 At most 1 02412 38415 06233 MacKinnon-Haug-Michelis (1999) p-values

The Stock Market

Result

Only the Hungarian stock market index and the German stock market index are cointegrated The other stock market indices are not cointegrated with the German stock market index

22

Stock Market Integrationin Eastern Europe

The Stock Market

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Outline

Financial Market IntegrationStock Market (Integration)

Bond Market (Integration)

2

Stock Market Integration

Financial market integration means that spatially separated financial markets increasingly merge into a single financial market

Reduction of both capital flow barriers and erosion of the home bias effect (partially due to institutional integration) should increasingly lead market participants to consider shares of different countries as substitutes

4

Stock Market Integrationin Eastern Europe

Perfect substitution requires elimination of exchange rate risk

For the Eastern European countries this precondition is not fulfilled Nevertheless trade within the EU member countries has increased tremendously (BORBEacuteLY 2006)

rarr Amplified synchronization of business cycles

rarr Interlinkages of capital markets should also strengthen

Measurement of financial (stock) market integration

rarr Eg correlation ldquobetardquo

5

Stock Market Integrationin Eastern Europe

The Capital Asset Pricing Model

The Capital Asset PricingModel (CAPM)

The market portfolio is central for the CAPM which assumes that the market portfolio lies on the efficient set and that all investors hold the market portfolio in combination with a desired amount of risk free borrowing and lending

(1)pm

fmfp

rrrr σsdot⎥

⎦

⎤⎢⎣

⎡σminus

+=

The Stock Market 7

(2)

(3)

βi (future) beta factor of security i

σiM covariance between the future returns of security i (ri) and the securities of the market (rM)

variance of the future returns of the market

)rr(r)r(E fMifi minusβ+=

2M

iM

m

mii )r(Var

)rr(Covσσ

==β

2Mσ

The Capital Asset PricingModel (CAPM)

The Stock Market 8

The Beta factor measures the market risk (systematic risk) of a security

It is the risk component which cannot be eliminated throughdiversification

The second risk component ndash unsystematic risk (non-market risk) ndashcan be diversified away and it therefore will not be compensated (bythe market)

The Capital Asset PricingModel (CAPM)

The Stock Market 9

The Market Model

The Market ModelThe return on a common stock is assumed to be related to the return on a market index (eg FTSE100) in the following manner

(4)

where riI = return on security i for some given periodrI = return on market index for the same periodαiI = intercept termβiI = slope termεiI = random error term

iIIiIiIi rr ε+β+α=

The Stock Market 11

The International CAPM

International CAPME(ri ndash rh) = γ1Cov(rirw) + γ2Cov(ri ) (1)

ri return on security irw return on world market portfoliorh interest rate on domestic bonds

relative change of exchange rateγ1 and γ2 prices of the respective covariance risks

Problem with (1)γ1 and γ2 must be determined somehow

e

The Stock Market

amp

eamp

13

International CAPMrw and interest rate on foreign bonds are used as benchmarks

E(rw ndash rh) == (2)

+ rf ndash rh == (3)

+ rf expected return on foreign bonds (denominated in domesticcurrency)

The Stock Market

)eCov(rγ)rCov(rγ w2

ww1 amp+

)(eE amp)(eE amp

)e(ampE )eeCov(γ)reCov(γ 2w

1 ampampamp +)eVar(γ)reCov(γ 2

w1 ampamp +

)eCov(rγ)Var(rγ w2

w1 amp+

)e(ampE

14

International CAPMAssumptionfrom (2) and (3) resultrarr

(4)

(5)

(4) and (5) in (1)

The Stock Market

0)reCov( w =amp

)Var(rr)E(rγ w

hw

1minus

=

)eVar(rr)eE(γ

hf

2 ampamp minus+

=

15

International CAPM

(6)

β1 and β2 (sensitivity measures ) can be estimated as follows

ut ~ (0 σ2)

The Stock Market

)eCov(r)eVar(

)rreE()rCov(r)Var(r)rE(r)rE(r i

hfw

iw

hwh

i ampamp

ampsdot

minus++sdot

minus=minus

)rreE()eVar(

)eCov(r)rE(r)Var(r

)rCov(r hfihww

wi minus+sdot+minussdot= amp

ampamp

)rreE(β)rE(rβ hf2i

hw1i minus+sdot+minussdot= amp

t2iw1ii ueβrβαr +sdot+sdot+= amp

16

Technique employedCointegration Approach

SPit = α + βDAXt + ut (requirement α=0 β=1)

Eight Eastern European countries are considered ie Poland Czech Republic Slovenia and Hungary Estonia Lithuania Latvia and the Slovak Republic

The benchmark market is the German stock market (DAX is used as a proxy)

Monthly data are used covering the period from March 1995 to August 2008 except for Estonia (with the starting point August 1996) Lithuania (with the starting point February 2000) and Latvia (with the starting point March 2000)

17

Stock Market Integrationin Eastern Europe

The Stock Market

18

Stock Market Integrationin Eastern Europe

ytt00t zxbay ++=

xtt11t zybax ++=

(1)

(2)

yt

yn

1jjtyj

xn

1jjtxj

y1-tz

1t001tyy0t uyaxa)xbay(y +sum Δ+sum Δ+minusminusγminusγ=Δ

=minus

=minus

=

minusminus 444 3444 21

xt

n

1jjtyj

n

1jjtxj

z

1t001txx0t uΔybΔxb)xba(yγγΔx

yx

y1t

+++minusminus+= sumsum=

minus=

minus

=

minusminus

minus

444 3444 21

(3)

(4)

Cointegration Approach

The Stock Market

(5)

(6)

(trace-test)

tptp2t21t1t UYAYAYAY

19

Stock Market Integrationin Eastern Europe

++++= minusminusminus

t1pt

1p2t

21t

11tt UYAYAYAYY +Δ++Δ+Δ+Πminus=Δ +minusminusminusminusminus

summinus=Π=

p

1jjAI

1p 2 1j AAp

1jii

j minus=summinus=

+=

sum λminus=+=

k

1rii )ˆ1ln()r(Tr

The Stock Market

20

Stock Market Integrationin Eastern Europe

Series Germany-Czech Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 631767 154947 06580 At most 1 06407 38415 04235 Series Germany-Estonia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 143109 154947 00748 At most 1 31338 38415 00767 Series Germany-Hungary Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 169329 154947 00302 At most 1 28928 38415 00890 Series Germany-Latvia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 163184 154947 00375 At most 1 57756 38415 00162

The Stock Market

21

Stock Market Integrationin Eastern Europe

Series Germany-Lithuania Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 167550 154947 00322 At most 1 47125 38415 00299 Series Germany-Poland Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 118812 154947 01627 At most 1 25319 38415 01116 Series Germany-Slovak Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 64957 154947 06369 At most 1 00518 38415 08200 Series Germany-Slovenia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 42741 154947 08802 At most 1 02412 38415 06233 MacKinnon-Haug-Michelis (1999) p-values

The Stock Market

Result

Only the Hungarian stock market index and the German stock market index are cointegrated The other stock market indices are not cointegrated with the German stock market index

22

Stock Market Integrationin Eastern Europe

The Stock Market

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Stock Market Integration

Financial market integration means that spatially separated financial markets increasingly merge into a single financial market

Reduction of both capital flow barriers and erosion of the home bias effect (partially due to institutional integration) should increasingly lead market participants to consider shares of different countries as substitutes

4

Stock Market Integrationin Eastern Europe

Perfect substitution requires elimination of exchange rate risk

For the Eastern European countries this precondition is not fulfilled Nevertheless trade within the EU member countries has increased tremendously (BORBEacuteLY 2006)

rarr Amplified synchronization of business cycles

rarr Interlinkages of capital markets should also strengthen

Measurement of financial (stock) market integration

rarr Eg correlation ldquobetardquo

5

Stock Market Integrationin Eastern Europe

The Capital Asset Pricing Model

The Capital Asset PricingModel (CAPM)

The market portfolio is central for the CAPM which assumes that the market portfolio lies on the efficient set and that all investors hold the market portfolio in combination with a desired amount of risk free borrowing and lending

(1)pm

fmfp

rrrr σsdot⎥

⎦

⎤⎢⎣

⎡σminus

+=

The Stock Market 7

(2)

(3)

βi (future) beta factor of security i

σiM covariance between the future returns of security i (ri) and the securities of the market (rM)

variance of the future returns of the market

)rr(r)r(E fMifi minusβ+=

2M

iM

m

mii )r(Var

)rr(Covσσ

==β

2Mσ

The Capital Asset PricingModel (CAPM)

The Stock Market 8

The Beta factor measures the market risk (systematic risk) of a security

It is the risk component which cannot be eliminated throughdiversification

The second risk component ndash unsystematic risk (non-market risk) ndashcan be diversified away and it therefore will not be compensated (bythe market)

The Capital Asset PricingModel (CAPM)

The Stock Market 9

The Market Model

The Market ModelThe return on a common stock is assumed to be related to the return on a market index (eg FTSE100) in the following manner

(4)

where riI = return on security i for some given periodrI = return on market index for the same periodαiI = intercept termβiI = slope termεiI = random error term

iIIiIiIi rr ε+β+α=

The Stock Market 11

The International CAPM

International CAPME(ri ndash rh) = γ1Cov(rirw) + γ2Cov(ri ) (1)

ri return on security irw return on world market portfoliorh interest rate on domestic bonds

relative change of exchange rateγ1 and γ2 prices of the respective covariance risks

Problem with (1)γ1 and γ2 must be determined somehow

e

The Stock Market

amp

eamp

13

International CAPMrw and interest rate on foreign bonds are used as benchmarks

E(rw ndash rh) == (2)

+ rf ndash rh == (3)

+ rf expected return on foreign bonds (denominated in domesticcurrency)

The Stock Market

)eCov(rγ)rCov(rγ w2

ww1 amp+

)(eE amp)(eE amp

)e(ampE )eeCov(γ)reCov(γ 2w

1 ampampamp +)eVar(γ)reCov(γ 2

w1 ampamp +

)eCov(rγ)Var(rγ w2

w1 amp+

)e(ampE

14

International CAPMAssumptionfrom (2) and (3) resultrarr

(4)

(5)

(4) and (5) in (1)

The Stock Market

0)reCov( w =amp

)Var(rr)E(rγ w

hw

1minus

=

)eVar(rr)eE(γ

hf

2 ampamp minus+

=

15

International CAPM

(6)

β1 and β2 (sensitivity measures ) can be estimated as follows

ut ~ (0 σ2)

The Stock Market

)eCov(r)eVar(

)rreE()rCov(r)Var(r)rE(r)rE(r i

hfw

iw

hwh

i ampamp

ampsdot

minus++sdot

minus=minus

)rreE()eVar(

)eCov(r)rE(r)Var(r

)rCov(r hfihww

wi minus+sdot+minussdot= amp

ampamp

)rreE(β)rE(rβ hf2i

hw1i minus+sdot+minussdot= amp

t2iw1ii ueβrβαr +sdot+sdot+= amp

16

Technique employedCointegration Approach

SPit = α + βDAXt + ut (requirement α=0 β=1)

Eight Eastern European countries are considered ie Poland Czech Republic Slovenia and Hungary Estonia Lithuania Latvia and the Slovak Republic

The benchmark market is the German stock market (DAX is used as a proxy)

Monthly data are used covering the period from March 1995 to August 2008 except for Estonia (with the starting point August 1996) Lithuania (with the starting point February 2000) and Latvia (with the starting point March 2000)

17

Stock Market Integrationin Eastern Europe

The Stock Market

18

Stock Market Integrationin Eastern Europe

ytt00t zxbay ++=

xtt11t zybax ++=

(1)

(2)

yt

yn

1jjtyj

xn

1jjtxj

y1-tz

1t001tyy0t uyaxa)xbay(y +sum Δ+sum Δ+minusminusγminusγ=Δ

=minus

=minus

=

minusminus 444 3444 21

xt

n

1jjtyj

n

1jjtxj

z

1t001txx0t uΔybΔxb)xba(yγγΔx

yx

y1t

+++minusminus+= sumsum=

minus=

minus

=

minusminus

minus

444 3444 21

(3)

(4)

Cointegration Approach

The Stock Market

(5)

(6)

(trace-test)

tptp2t21t1t UYAYAYAY

19

Stock Market Integrationin Eastern Europe

++++= minusminusminus

t1pt

1p2t

21t

11tt UYAYAYAYY +Δ++Δ+Δ+Πminus=Δ +minusminusminusminusminus

summinus=Π=

p

1jjAI

1p 2 1j AAp

1jii

j minus=summinus=

+=

sum λminus=+=

k

1rii )ˆ1ln()r(Tr

The Stock Market

20

Stock Market Integrationin Eastern Europe

Series Germany-Czech Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 631767 154947 06580 At most 1 06407 38415 04235 Series Germany-Estonia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 143109 154947 00748 At most 1 31338 38415 00767 Series Germany-Hungary Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 169329 154947 00302 At most 1 28928 38415 00890 Series Germany-Latvia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 163184 154947 00375 At most 1 57756 38415 00162

The Stock Market

21

Stock Market Integrationin Eastern Europe

Series Germany-Lithuania Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 167550 154947 00322 At most 1 47125 38415 00299 Series Germany-Poland Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 118812 154947 01627 At most 1 25319 38415 01116 Series Germany-Slovak Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 64957 154947 06369 At most 1 00518 38415 08200 Series Germany-Slovenia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 42741 154947 08802 At most 1 02412 38415 06233 MacKinnon-Haug-Michelis (1999) p-values

The Stock Market

Result

Only the Hungarian stock market index and the German stock market index are cointegrated The other stock market indices are not cointegrated with the German stock market index

22

Stock Market Integrationin Eastern Europe

The Stock Market

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Financial market integration means that spatially separated financial markets increasingly merge into a single financial market

Reduction of both capital flow barriers and erosion of the home bias effect (partially due to institutional integration) should increasingly lead market participants to consider shares of different countries as substitutes

4

Stock Market Integrationin Eastern Europe

Perfect substitution requires elimination of exchange rate risk

For the Eastern European countries this precondition is not fulfilled Nevertheless trade within the EU member countries has increased tremendously (BORBEacuteLY 2006)

rarr Amplified synchronization of business cycles

rarr Interlinkages of capital markets should also strengthen

Measurement of financial (stock) market integration

rarr Eg correlation ldquobetardquo

5

Stock Market Integrationin Eastern Europe

The Capital Asset Pricing Model

The Capital Asset PricingModel (CAPM)

The market portfolio is central for the CAPM which assumes that the market portfolio lies on the efficient set and that all investors hold the market portfolio in combination with a desired amount of risk free borrowing and lending

(1)pm

fmfp

rrrr σsdot⎥

⎦

⎤⎢⎣

⎡σminus

+=

The Stock Market 7

(2)

(3)

βi (future) beta factor of security i

σiM covariance between the future returns of security i (ri) and the securities of the market (rM)

variance of the future returns of the market

)rr(r)r(E fMifi minusβ+=

2M

iM

m

mii )r(Var

)rr(Covσσ

==β

2Mσ

The Capital Asset PricingModel (CAPM)

The Stock Market 8

The Beta factor measures the market risk (systematic risk) of a security

It is the risk component which cannot be eliminated throughdiversification

The second risk component ndash unsystematic risk (non-market risk) ndashcan be diversified away and it therefore will not be compensated (bythe market)

The Capital Asset PricingModel (CAPM)

The Stock Market 9

The Market Model

The Market ModelThe return on a common stock is assumed to be related to the return on a market index (eg FTSE100) in the following manner

(4)

where riI = return on security i for some given periodrI = return on market index for the same periodαiI = intercept termβiI = slope termεiI = random error term

iIIiIiIi rr ε+β+α=

The Stock Market 11

The International CAPM

International CAPME(ri ndash rh) = γ1Cov(rirw) + γ2Cov(ri ) (1)

ri return on security irw return on world market portfoliorh interest rate on domestic bonds

relative change of exchange rateγ1 and γ2 prices of the respective covariance risks

Problem with (1)γ1 and γ2 must be determined somehow

e

The Stock Market

amp

eamp

13

International CAPMrw and interest rate on foreign bonds are used as benchmarks

E(rw ndash rh) == (2)

+ rf ndash rh == (3)

+ rf expected return on foreign bonds (denominated in domesticcurrency)

The Stock Market

)eCov(rγ)rCov(rγ w2

ww1 amp+

)(eE amp)(eE amp

)e(ampE )eeCov(γ)reCov(γ 2w

1 ampampamp +)eVar(γ)reCov(γ 2

w1 ampamp +

)eCov(rγ)Var(rγ w2

w1 amp+

)e(ampE

14

International CAPMAssumptionfrom (2) and (3) resultrarr

(4)

(5)

(4) and (5) in (1)

The Stock Market

0)reCov( w =amp

)Var(rr)E(rγ w

hw

1minus

=

)eVar(rr)eE(γ

hf

2 ampamp minus+

=

15

International CAPM

(6)

β1 and β2 (sensitivity measures ) can be estimated as follows

ut ~ (0 σ2)

The Stock Market

)eCov(r)eVar(

)rreE()rCov(r)Var(r)rE(r)rE(r i

hfw

iw

hwh

i ampamp

ampsdot

minus++sdot

minus=minus

)rreE()eVar(

)eCov(r)rE(r)Var(r

)rCov(r hfihww

wi minus+sdot+minussdot= amp

ampamp

)rreE(β)rE(rβ hf2i

hw1i minus+sdot+minussdot= amp

t2iw1ii ueβrβαr +sdot+sdot+= amp

16

Technique employedCointegration Approach

SPit = α + βDAXt + ut (requirement α=0 β=1)

Eight Eastern European countries are considered ie Poland Czech Republic Slovenia and Hungary Estonia Lithuania Latvia and the Slovak Republic

The benchmark market is the German stock market (DAX is used as a proxy)

Monthly data are used covering the period from March 1995 to August 2008 except for Estonia (with the starting point August 1996) Lithuania (with the starting point February 2000) and Latvia (with the starting point March 2000)

17

Stock Market Integrationin Eastern Europe

The Stock Market

18

Stock Market Integrationin Eastern Europe

ytt00t zxbay ++=

xtt11t zybax ++=

(1)

(2)

yt

yn

1jjtyj

xn

1jjtxj

y1-tz

1t001tyy0t uyaxa)xbay(y +sum Δ+sum Δ+minusminusγminusγ=Δ

=minus

=minus

=

minusminus 444 3444 21

xt

n

1jjtyj

n

1jjtxj

z

1t001txx0t uΔybΔxb)xba(yγγΔx

yx

y1t

+++minusminus+= sumsum=

minus=

minus

=

minusminus

minus

444 3444 21

(3)

(4)

Cointegration Approach

The Stock Market

(5)

(6)

(trace-test)

tptp2t21t1t UYAYAYAY

19

Stock Market Integrationin Eastern Europe

++++= minusminusminus

t1pt

1p2t

21t

11tt UYAYAYAYY +Δ++Δ+Δ+Πminus=Δ +minusminusminusminusminus

summinus=Π=

p

1jjAI

1p 2 1j AAp

1jii

j minus=summinus=

+=

sum λminus=+=

k

1rii )ˆ1ln()r(Tr

The Stock Market

20

Stock Market Integrationin Eastern Europe

Series Germany-Czech Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 631767 154947 06580 At most 1 06407 38415 04235 Series Germany-Estonia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 143109 154947 00748 At most 1 31338 38415 00767 Series Germany-Hungary Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 169329 154947 00302 At most 1 28928 38415 00890 Series Germany-Latvia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 163184 154947 00375 At most 1 57756 38415 00162

The Stock Market

21

Stock Market Integrationin Eastern Europe

Series Germany-Lithuania Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 167550 154947 00322 At most 1 47125 38415 00299 Series Germany-Poland Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 118812 154947 01627 At most 1 25319 38415 01116 Series Germany-Slovak Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 64957 154947 06369 At most 1 00518 38415 08200 Series Germany-Slovenia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 42741 154947 08802 At most 1 02412 38415 06233 MacKinnon-Haug-Michelis (1999) p-values

The Stock Market

Result

Only the Hungarian stock market index and the German stock market index are cointegrated The other stock market indices are not cointegrated with the German stock market index

22

Stock Market Integrationin Eastern Europe

The Stock Market

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Perfect substitution requires elimination of exchange rate risk

For the Eastern European countries this precondition is not fulfilled Nevertheless trade within the EU member countries has increased tremendously (BORBEacuteLY 2006)

rarr Amplified synchronization of business cycles

rarr Interlinkages of capital markets should also strengthen

Measurement of financial (stock) market integration

rarr Eg correlation ldquobetardquo

5

Stock Market Integrationin Eastern Europe

The Capital Asset Pricing Model

The Capital Asset PricingModel (CAPM)

The market portfolio is central for the CAPM which assumes that the market portfolio lies on the efficient set and that all investors hold the market portfolio in combination with a desired amount of risk free borrowing and lending

(1)pm

fmfp

rrrr σsdot⎥

⎦

⎤⎢⎣

⎡σminus

+=

The Stock Market 7

(2)

(3)

βi (future) beta factor of security i

σiM covariance between the future returns of security i (ri) and the securities of the market (rM)

variance of the future returns of the market

)rr(r)r(E fMifi minusβ+=

2M

iM

m

mii )r(Var

)rr(Covσσ

==β

2Mσ

The Capital Asset PricingModel (CAPM)

The Stock Market 8

The Beta factor measures the market risk (systematic risk) of a security

It is the risk component which cannot be eliminated throughdiversification

The second risk component ndash unsystematic risk (non-market risk) ndashcan be diversified away and it therefore will not be compensated (bythe market)

The Capital Asset PricingModel (CAPM)

The Stock Market 9

The Market Model

The Market ModelThe return on a common stock is assumed to be related to the return on a market index (eg FTSE100) in the following manner

(4)

where riI = return on security i for some given periodrI = return on market index for the same periodαiI = intercept termβiI = slope termεiI = random error term

iIIiIiIi rr ε+β+α=

The Stock Market 11

The International CAPM

International CAPME(ri ndash rh) = γ1Cov(rirw) + γ2Cov(ri ) (1)

ri return on security irw return on world market portfoliorh interest rate on domestic bonds

relative change of exchange rateγ1 and γ2 prices of the respective covariance risks

Problem with (1)γ1 and γ2 must be determined somehow

e

The Stock Market

amp

eamp

13

International CAPMrw and interest rate on foreign bonds are used as benchmarks

E(rw ndash rh) == (2)

+ rf ndash rh == (3)

+ rf expected return on foreign bonds (denominated in domesticcurrency)

The Stock Market

)eCov(rγ)rCov(rγ w2

ww1 amp+

)(eE amp)(eE amp

)e(ampE )eeCov(γ)reCov(γ 2w

1 ampampamp +)eVar(γ)reCov(γ 2

w1 ampamp +

)eCov(rγ)Var(rγ w2

w1 amp+

)e(ampE

14

International CAPMAssumptionfrom (2) and (3) resultrarr

(4)

(5)

(4) and (5) in (1)

The Stock Market

0)reCov( w =amp

)Var(rr)E(rγ w

hw

1minus

=

)eVar(rr)eE(γ

hf

2 ampamp minus+

=

15

International CAPM

(6)

β1 and β2 (sensitivity measures ) can be estimated as follows

ut ~ (0 σ2)

The Stock Market

)eCov(r)eVar(

)rreE()rCov(r)Var(r)rE(r)rE(r i

hfw

iw

hwh

i ampamp

ampsdot

minus++sdot

minus=minus

)rreE()eVar(

)eCov(r)rE(r)Var(r

)rCov(r hfihww

wi minus+sdot+minussdot= amp

ampamp

)rreE(β)rE(rβ hf2i

hw1i minus+sdot+minussdot= amp

t2iw1ii ueβrβαr +sdot+sdot+= amp

16

Technique employedCointegration Approach

SPit = α + βDAXt + ut (requirement α=0 β=1)

Eight Eastern European countries are considered ie Poland Czech Republic Slovenia and Hungary Estonia Lithuania Latvia and the Slovak Republic

The benchmark market is the German stock market (DAX is used as a proxy)

Monthly data are used covering the period from March 1995 to August 2008 except for Estonia (with the starting point August 1996) Lithuania (with the starting point February 2000) and Latvia (with the starting point March 2000)

17

Stock Market Integrationin Eastern Europe

The Stock Market

18

Stock Market Integrationin Eastern Europe

ytt00t zxbay ++=

xtt11t zybax ++=

(1)

(2)

yt

yn

1jjtyj

xn

1jjtxj

y1-tz

1t001tyy0t uyaxa)xbay(y +sum Δ+sum Δ+minusminusγminusγ=Δ

=minus

=minus

=

minusminus 444 3444 21

xt

n

1jjtyj

n

1jjtxj

z

1t001txx0t uΔybΔxb)xba(yγγΔx

yx

y1t

+++minusminus+= sumsum=

minus=

minus

=

minusminus

minus

444 3444 21

(3)

(4)

Cointegration Approach

The Stock Market

(5)

(6)

(trace-test)

tptp2t21t1t UYAYAYAY

19

Stock Market Integrationin Eastern Europe

++++= minusminusminus

t1pt

1p2t

21t

11tt UYAYAYAYY +Δ++Δ+Δ+Πminus=Δ +minusminusminusminusminus

summinus=Π=

p

1jjAI

1p 2 1j AAp

1jii

j minus=summinus=

+=

sum λminus=+=

k

1rii )ˆ1ln()r(Tr

The Stock Market

20

Stock Market Integrationin Eastern Europe

Series Germany-Czech Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 631767 154947 06580 At most 1 06407 38415 04235 Series Germany-Estonia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 143109 154947 00748 At most 1 31338 38415 00767 Series Germany-Hungary Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 169329 154947 00302 At most 1 28928 38415 00890 Series Germany-Latvia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 163184 154947 00375 At most 1 57756 38415 00162

The Stock Market

21

Stock Market Integrationin Eastern Europe

Series Germany-Lithuania Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 167550 154947 00322 At most 1 47125 38415 00299 Series Germany-Poland Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 118812 154947 01627 At most 1 25319 38415 01116 Series Germany-Slovak Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 64957 154947 06369 At most 1 00518 38415 08200 Series Germany-Slovenia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 42741 154947 08802 At most 1 02412 38415 06233 MacKinnon-Haug-Michelis (1999) p-values

The Stock Market

Result

Only the Hungarian stock market index and the German stock market index are cointegrated The other stock market indices are not cointegrated with the German stock market index

22

Stock Market Integrationin Eastern Europe

The Stock Market

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

The Capital Asset Pricing Model

The Capital Asset PricingModel (CAPM)

The market portfolio is central for the CAPM which assumes that the market portfolio lies on the efficient set and that all investors hold the market portfolio in combination with a desired amount of risk free borrowing and lending

(1)pm

fmfp

rrrr σsdot⎥

⎦

⎤⎢⎣

⎡σminus

+=

The Stock Market 7

(2)

(3)

βi (future) beta factor of security i

σiM covariance between the future returns of security i (ri) and the securities of the market (rM)

variance of the future returns of the market

)rr(r)r(E fMifi minusβ+=

2M

iM

m

mii )r(Var

)rr(Covσσ

==β

2Mσ

The Capital Asset PricingModel (CAPM)

The Stock Market 8

The Beta factor measures the market risk (systematic risk) of a security

It is the risk component which cannot be eliminated throughdiversification

The second risk component ndash unsystematic risk (non-market risk) ndashcan be diversified away and it therefore will not be compensated (bythe market)

The Capital Asset PricingModel (CAPM)

The Stock Market 9

The Market Model

The Market ModelThe return on a common stock is assumed to be related to the return on a market index (eg FTSE100) in the following manner

(4)

where riI = return on security i for some given periodrI = return on market index for the same periodαiI = intercept termβiI = slope termεiI = random error term

iIIiIiIi rr ε+β+α=

The Stock Market 11

The International CAPM

International CAPME(ri ndash rh) = γ1Cov(rirw) + γ2Cov(ri ) (1)

ri return on security irw return on world market portfoliorh interest rate on domestic bonds

relative change of exchange rateγ1 and γ2 prices of the respective covariance risks

Problem with (1)γ1 and γ2 must be determined somehow

e

The Stock Market

amp

eamp

13

International CAPMrw and interest rate on foreign bonds are used as benchmarks

E(rw ndash rh) == (2)

+ rf ndash rh == (3)

+ rf expected return on foreign bonds (denominated in domesticcurrency)

The Stock Market

)eCov(rγ)rCov(rγ w2

ww1 amp+

)(eE amp)(eE amp

)e(ampE )eeCov(γ)reCov(γ 2w

1 ampampamp +)eVar(γ)reCov(γ 2

w1 ampamp +

)eCov(rγ)Var(rγ w2

w1 amp+

)e(ampE

14

International CAPMAssumptionfrom (2) and (3) resultrarr

(4)

(5)

(4) and (5) in (1)

The Stock Market

0)reCov( w =amp

)Var(rr)E(rγ w

hw

1minus

=

)eVar(rr)eE(γ

hf

2 ampamp minus+

=

15

International CAPM

(6)

β1 and β2 (sensitivity measures ) can be estimated as follows

ut ~ (0 σ2)

The Stock Market

)eCov(r)eVar(

)rreE()rCov(r)Var(r)rE(r)rE(r i

hfw

iw

hwh

i ampamp

ampsdot

minus++sdot

minus=minus

)rreE()eVar(

)eCov(r)rE(r)Var(r

)rCov(r hfihww

wi minus+sdot+minussdot= amp

ampamp

)rreE(β)rE(rβ hf2i

hw1i minus+sdot+minussdot= amp

t2iw1ii ueβrβαr +sdot+sdot+= amp

16

Technique employedCointegration Approach

SPit = α + βDAXt + ut (requirement α=0 β=1)

Eight Eastern European countries are considered ie Poland Czech Republic Slovenia and Hungary Estonia Lithuania Latvia and the Slovak Republic

The benchmark market is the German stock market (DAX is used as a proxy)

Monthly data are used covering the period from March 1995 to August 2008 except for Estonia (with the starting point August 1996) Lithuania (with the starting point February 2000) and Latvia (with the starting point March 2000)

17

Stock Market Integrationin Eastern Europe

The Stock Market

18

Stock Market Integrationin Eastern Europe

ytt00t zxbay ++=

xtt11t zybax ++=

(1)

(2)

yt

yn

1jjtyj

xn

1jjtxj

y1-tz

1t001tyy0t uyaxa)xbay(y +sum Δ+sum Δ+minusminusγminusγ=Δ

=minus

=minus

=

minusminus 444 3444 21

xt

n

1jjtyj

n

1jjtxj

z

1t001txx0t uΔybΔxb)xba(yγγΔx

yx

y1t

+++minusminus+= sumsum=

minus=

minus

=

minusminus

minus

444 3444 21

(3)

(4)

Cointegration Approach

The Stock Market

(5)

(6)

(trace-test)

tptp2t21t1t UYAYAYAY

19

Stock Market Integrationin Eastern Europe

++++= minusminusminus

t1pt

1p2t

21t

11tt UYAYAYAYY +Δ++Δ+Δ+Πminus=Δ +minusminusminusminusminus

summinus=Π=

p

1jjAI

1p 2 1j AAp

1jii

j minus=summinus=

+=

sum λminus=+=

k

1rii )ˆ1ln()r(Tr

The Stock Market

20

Stock Market Integrationin Eastern Europe

Series Germany-Czech Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 631767 154947 06580 At most 1 06407 38415 04235 Series Germany-Estonia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 143109 154947 00748 At most 1 31338 38415 00767 Series Germany-Hungary Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 169329 154947 00302 At most 1 28928 38415 00890 Series Germany-Latvia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 163184 154947 00375 At most 1 57756 38415 00162

The Stock Market

21

Stock Market Integrationin Eastern Europe

Series Germany-Lithuania Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 167550 154947 00322 At most 1 47125 38415 00299 Series Germany-Poland Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 118812 154947 01627 At most 1 25319 38415 01116 Series Germany-Slovak Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 64957 154947 06369 At most 1 00518 38415 08200 Series Germany-Slovenia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 42741 154947 08802 At most 1 02412 38415 06233 MacKinnon-Haug-Michelis (1999) p-values

The Stock Market

Result

Only the Hungarian stock market index and the German stock market index are cointegrated The other stock market indices are not cointegrated with the German stock market index

22

Stock Market Integrationin Eastern Europe

The Stock Market

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

The Capital Asset PricingModel (CAPM)

The market portfolio is central for the CAPM which assumes that the market portfolio lies on the efficient set and that all investors hold the market portfolio in combination with a desired amount of risk free borrowing and lending

(1)pm

fmfp

rrrr σsdot⎥

⎦

⎤⎢⎣

⎡σminus

+=

The Stock Market 7

(2)

(3)

βi (future) beta factor of security i

σiM covariance between the future returns of security i (ri) and the securities of the market (rM)

variance of the future returns of the market

)rr(r)r(E fMifi minusβ+=

2M

iM

m

mii )r(Var

)rr(Covσσ

==β

2Mσ

The Capital Asset PricingModel (CAPM)

The Stock Market 8

The Beta factor measures the market risk (systematic risk) of a security

It is the risk component which cannot be eliminated throughdiversification

The second risk component ndash unsystematic risk (non-market risk) ndashcan be diversified away and it therefore will not be compensated (bythe market)

The Capital Asset PricingModel (CAPM)

The Stock Market 9

The Market Model

The Market ModelThe return on a common stock is assumed to be related to the return on a market index (eg FTSE100) in the following manner

(4)

where riI = return on security i for some given periodrI = return on market index for the same periodαiI = intercept termβiI = slope termεiI = random error term

iIIiIiIi rr ε+β+α=

The Stock Market 11

The International CAPM

International CAPME(ri ndash rh) = γ1Cov(rirw) + γ2Cov(ri ) (1)

ri return on security irw return on world market portfoliorh interest rate on domestic bonds

relative change of exchange rateγ1 and γ2 prices of the respective covariance risks

Problem with (1)γ1 and γ2 must be determined somehow

e

The Stock Market

amp

eamp

13

International CAPMrw and interest rate on foreign bonds are used as benchmarks

E(rw ndash rh) == (2)

+ rf ndash rh == (3)

+ rf expected return on foreign bonds (denominated in domesticcurrency)

The Stock Market

)eCov(rγ)rCov(rγ w2

ww1 amp+

)(eE amp)(eE amp

)e(ampE )eeCov(γ)reCov(γ 2w

1 ampampamp +)eVar(γ)reCov(γ 2

w1 ampamp +

)eCov(rγ)Var(rγ w2

w1 amp+

)e(ampE

14

International CAPMAssumptionfrom (2) and (3) resultrarr

(4)

(5)

(4) and (5) in (1)

The Stock Market

0)reCov( w =amp

)Var(rr)E(rγ w

hw

1minus

=

)eVar(rr)eE(γ

hf

2 ampamp minus+

=

15

International CAPM

(6)

β1 and β2 (sensitivity measures ) can be estimated as follows

ut ~ (0 σ2)

The Stock Market

)eCov(r)eVar(

)rreE()rCov(r)Var(r)rE(r)rE(r i

hfw

iw

hwh

i ampamp

ampsdot

minus++sdot

minus=minus

)rreE()eVar(

)eCov(r)rE(r)Var(r

)rCov(r hfihww

wi minus+sdot+minussdot= amp

ampamp

)rreE(β)rE(rβ hf2i

hw1i minus+sdot+minussdot= amp

t2iw1ii ueβrβαr +sdot+sdot+= amp

16

Technique employedCointegration Approach

SPit = α + βDAXt + ut (requirement α=0 β=1)

Eight Eastern European countries are considered ie Poland Czech Republic Slovenia and Hungary Estonia Lithuania Latvia and the Slovak Republic

The benchmark market is the German stock market (DAX is used as a proxy)

Monthly data are used covering the period from March 1995 to August 2008 except for Estonia (with the starting point August 1996) Lithuania (with the starting point February 2000) and Latvia (with the starting point March 2000)

17

Stock Market Integrationin Eastern Europe

The Stock Market

18

Stock Market Integrationin Eastern Europe

ytt00t zxbay ++=

xtt11t zybax ++=

(1)

(2)

yt

yn

1jjtyj

xn

1jjtxj

y1-tz

1t001tyy0t uyaxa)xbay(y +sum Δ+sum Δ+minusminusγminusγ=Δ

=minus

=minus

=

minusminus 444 3444 21

xt

n

1jjtyj

n

1jjtxj

z

1t001txx0t uΔybΔxb)xba(yγγΔx

yx

y1t

+++minusminus+= sumsum=

minus=

minus

=

minusminus

minus

444 3444 21

(3)

(4)

Cointegration Approach

The Stock Market

(5)

(6)

(trace-test)

tptp2t21t1t UYAYAYAY

19

Stock Market Integrationin Eastern Europe

++++= minusminusminus

t1pt

1p2t

21t

11tt UYAYAYAYY +Δ++Δ+Δ+Πminus=Δ +minusminusminusminusminus

summinus=Π=

p

1jjAI

1p 2 1j AAp

1jii

j minus=summinus=

+=

sum λminus=+=

k

1rii )ˆ1ln()r(Tr

The Stock Market

20

Stock Market Integrationin Eastern Europe

Series Germany-Czech Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 631767 154947 06580 At most 1 06407 38415 04235 Series Germany-Estonia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 143109 154947 00748 At most 1 31338 38415 00767 Series Germany-Hungary Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 169329 154947 00302 At most 1 28928 38415 00890 Series Germany-Latvia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 163184 154947 00375 At most 1 57756 38415 00162

The Stock Market

21

Stock Market Integrationin Eastern Europe

Series Germany-Lithuania Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 167550 154947 00322 At most 1 47125 38415 00299 Series Germany-Poland Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 118812 154947 01627 At most 1 25319 38415 01116 Series Germany-Slovak Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 64957 154947 06369 At most 1 00518 38415 08200 Series Germany-Slovenia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 42741 154947 08802 At most 1 02412 38415 06233 MacKinnon-Haug-Michelis (1999) p-values

The Stock Market

Result

Only the Hungarian stock market index and the German stock market index are cointegrated The other stock market indices are not cointegrated with the German stock market index

22

Stock Market Integrationin Eastern Europe

The Stock Market

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

(2)

(3)

βi (future) beta factor of security i

σiM covariance between the future returns of security i (ri) and the securities of the market (rM)

variance of the future returns of the market

)rr(r)r(E fMifi minusβ+=

2M

iM

m

mii )r(Var

)rr(Covσσ

==β

2Mσ

The Capital Asset PricingModel (CAPM)

The Stock Market 8

The Beta factor measures the market risk (systematic risk) of a security

It is the risk component which cannot be eliminated throughdiversification

The second risk component ndash unsystematic risk (non-market risk) ndashcan be diversified away and it therefore will not be compensated (bythe market)

The Capital Asset PricingModel (CAPM)

The Stock Market 9

The Market Model

The Market ModelThe return on a common stock is assumed to be related to the return on a market index (eg FTSE100) in the following manner

(4)

where riI = return on security i for some given periodrI = return on market index for the same periodαiI = intercept termβiI = slope termεiI = random error term

iIIiIiIi rr ε+β+α=

The Stock Market 11

The International CAPM

International CAPME(ri ndash rh) = γ1Cov(rirw) + γ2Cov(ri ) (1)

ri return on security irw return on world market portfoliorh interest rate on domestic bonds

relative change of exchange rateγ1 and γ2 prices of the respective covariance risks

Problem with (1)γ1 and γ2 must be determined somehow

e

The Stock Market

amp

eamp

13

International CAPMrw and interest rate on foreign bonds are used as benchmarks

E(rw ndash rh) == (2)

+ rf ndash rh == (3)

+ rf expected return on foreign bonds (denominated in domesticcurrency)

The Stock Market

)eCov(rγ)rCov(rγ w2

ww1 amp+

)(eE amp)(eE amp

)e(ampE )eeCov(γ)reCov(γ 2w

1 ampampamp +)eVar(γ)reCov(γ 2

w1 ampamp +

)eCov(rγ)Var(rγ w2

w1 amp+

)e(ampE

14

International CAPMAssumptionfrom (2) and (3) resultrarr

(4)

(5)

(4) and (5) in (1)

The Stock Market

0)reCov( w =amp

)Var(rr)E(rγ w

hw

1minus

=

)eVar(rr)eE(γ

hf

2 ampamp minus+

=

15

International CAPM

(6)

β1 and β2 (sensitivity measures ) can be estimated as follows

ut ~ (0 σ2)

The Stock Market

)eCov(r)eVar(

)rreE()rCov(r)Var(r)rE(r)rE(r i

hfw

iw

hwh

i ampamp

ampsdot

minus++sdot

minus=minus

)rreE()eVar(

)eCov(r)rE(r)Var(r

)rCov(r hfihww

wi minus+sdot+minussdot= amp

ampamp

)rreE(β)rE(rβ hf2i

hw1i minus+sdot+minussdot= amp

t2iw1ii ueβrβαr +sdot+sdot+= amp

16

Technique employedCointegration Approach

SPit = α + βDAXt + ut (requirement α=0 β=1)

Eight Eastern European countries are considered ie Poland Czech Republic Slovenia and Hungary Estonia Lithuania Latvia and the Slovak Republic

The benchmark market is the German stock market (DAX is used as a proxy)

Monthly data are used covering the period from March 1995 to August 2008 except for Estonia (with the starting point August 1996) Lithuania (with the starting point February 2000) and Latvia (with the starting point March 2000)

17

Stock Market Integrationin Eastern Europe

The Stock Market

18

Stock Market Integrationin Eastern Europe

ytt00t zxbay ++=

xtt11t zybax ++=

(1)

(2)

yt

yn

1jjtyj

xn

1jjtxj

y1-tz

1t001tyy0t uyaxa)xbay(y +sum Δ+sum Δ+minusminusγminusγ=Δ

=minus

=minus

=

minusminus 444 3444 21

xt

n

1jjtyj

n

1jjtxj

z

1t001txx0t uΔybΔxb)xba(yγγΔx

yx

y1t

+++minusminus+= sumsum=

minus=

minus

=

minusminus

minus

444 3444 21

(3)

(4)

Cointegration Approach

The Stock Market

(5)

(6)

(trace-test)

tptp2t21t1t UYAYAYAY

19

Stock Market Integrationin Eastern Europe

++++= minusminusminus

t1pt

1p2t

21t

11tt UYAYAYAYY +Δ++Δ+Δ+Πminus=Δ +minusminusminusminusminus

summinus=Π=

p

1jjAI

1p 2 1j AAp

1jii

j minus=summinus=

+=

sum λminus=+=

k

1rii )ˆ1ln()r(Tr

The Stock Market

20

Stock Market Integrationin Eastern Europe

Series Germany-Czech Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 631767 154947 06580 At most 1 06407 38415 04235 Series Germany-Estonia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 143109 154947 00748 At most 1 31338 38415 00767 Series Germany-Hungary Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 169329 154947 00302 At most 1 28928 38415 00890 Series Germany-Latvia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 163184 154947 00375 At most 1 57756 38415 00162

The Stock Market

21

Stock Market Integrationin Eastern Europe

Series Germany-Lithuania Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 167550 154947 00322 At most 1 47125 38415 00299 Series Germany-Poland Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 118812 154947 01627 At most 1 25319 38415 01116 Series Germany-Slovak Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 64957 154947 06369 At most 1 00518 38415 08200 Series Germany-Slovenia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 42741 154947 08802 At most 1 02412 38415 06233 MacKinnon-Haug-Michelis (1999) p-values

The Stock Market

Result

Only the Hungarian stock market index and the German stock market index are cointegrated The other stock market indices are not cointegrated with the German stock market index

22

Stock Market Integrationin Eastern Europe

The Stock Market

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

The Beta factor measures the market risk (systematic risk) of a security

It is the risk component which cannot be eliminated throughdiversification

The second risk component ndash unsystematic risk (non-market risk) ndashcan be diversified away and it therefore will not be compensated (bythe market)

The Capital Asset PricingModel (CAPM)

The Stock Market 9

The Market Model

The Market ModelThe return on a common stock is assumed to be related to the return on a market index (eg FTSE100) in the following manner

(4)

where riI = return on security i for some given periodrI = return on market index for the same periodαiI = intercept termβiI = slope termεiI = random error term

iIIiIiIi rr ε+β+α=

The Stock Market 11

The International CAPM

International CAPME(ri ndash rh) = γ1Cov(rirw) + γ2Cov(ri ) (1)

ri return on security irw return on world market portfoliorh interest rate on domestic bonds

relative change of exchange rateγ1 and γ2 prices of the respective covariance risks

Problem with (1)γ1 and γ2 must be determined somehow

e

The Stock Market

amp

eamp

13

International CAPMrw and interest rate on foreign bonds are used as benchmarks

E(rw ndash rh) == (2)

+ rf ndash rh == (3)

+ rf expected return on foreign bonds (denominated in domesticcurrency)

The Stock Market

)eCov(rγ)rCov(rγ w2

ww1 amp+

)(eE amp)(eE amp

)e(ampE )eeCov(γ)reCov(γ 2w

1 ampampamp +)eVar(γ)reCov(γ 2

w1 ampamp +

)eCov(rγ)Var(rγ w2

w1 amp+

)e(ampE

14

International CAPMAssumptionfrom (2) and (3) resultrarr

(4)

(5)

(4) and (5) in (1)

The Stock Market

0)reCov( w =amp

)Var(rr)E(rγ w

hw

1minus

=

)eVar(rr)eE(γ

hf

2 ampamp minus+

=

15

International CAPM

(6)

β1 and β2 (sensitivity measures ) can be estimated as follows

ut ~ (0 σ2)

The Stock Market

)eCov(r)eVar(

)rreE()rCov(r)Var(r)rE(r)rE(r i

hfw

iw

hwh

i ampamp

ampsdot

minus++sdot

minus=minus

)rreE()eVar(

)eCov(r)rE(r)Var(r

)rCov(r hfihww

wi minus+sdot+minussdot= amp

ampamp

)rreE(β)rE(rβ hf2i

hw1i minus+sdot+minussdot= amp

t2iw1ii ueβrβαr +sdot+sdot+= amp

16

Technique employedCointegration Approach

SPit = α + βDAXt + ut (requirement α=0 β=1)

Eight Eastern European countries are considered ie Poland Czech Republic Slovenia and Hungary Estonia Lithuania Latvia and the Slovak Republic

The benchmark market is the German stock market (DAX is used as a proxy)

Monthly data are used covering the period from March 1995 to August 2008 except for Estonia (with the starting point August 1996) Lithuania (with the starting point February 2000) and Latvia (with the starting point March 2000)

17

Stock Market Integrationin Eastern Europe

The Stock Market

18

Stock Market Integrationin Eastern Europe

ytt00t zxbay ++=

xtt11t zybax ++=

(1)

(2)

yt

yn

1jjtyj

xn

1jjtxj

y1-tz

1t001tyy0t uyaxa)xbay(y +sum Δ+sum Δ+minusminusγminusγ=Δ

=minus

=minus

=

minusminus 444 3444 21

xt

n

1jjtyj

n

1jjtxj

z

1t001txx0t uΔybΔxb)xba(yγγΔx

yx

y1t

+++minusminus+= sumsum=

minus=

minus

=

minusminus

minus

444 3444 21

(3)

(4)

Cointegration Approach

The Stock Market

(5)

(6)

(trace-test)

tptp2t21t1t UYAYAYAY

19

Stock Market Integrationin Eastern Europe

++++= minusminusminus

t1pt

1p2t

21t

11tt UYAYAYAYY +Δ++Δ+Δ+Πminus=Δ +minusminusminusminusminus

summinus=Π=

p

1jjAI

1p 2 1j AAp

1jii

j minus=summinus=

+=

sum λminus=+=

k

1rii )ˆ1ln()r(Tr

The Stock Market

20

Stock Market Integrationin Eastern Europe

Series Germany-Czech Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 631767 154947 06580 At most 1 06407 38415 04235 Series Germany-Estonia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 143109 154947 00748 At most 1 31338 38415 00767 Series Germany-Hungary Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 169329 154947 00302 At most 1 28928 38415 00890 Series Germany-Latvia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 163184 154947 00375 At most 1 57756 38415 00162

The Stock Market

21

Stock Market Integrationin Eastern Europe

Series Germany-Lithuania Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 167550 154947 00322 At most 1 47125 38415 00299 Series Germany-Poland Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 118812 154947 01627 At most 1 25319 38415 01116 Series Germany-Slovak Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 64957 154947 06369 At most 1 00518 38415 08200 Series Germany-Slovenia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 42741 154947 08802 At most 1 02412 38415 06233 MacKinnon-Haug-Michelis (1999) p-values

The Stock Market

Result

Only the Hungarian stock market index and the German stock market index are cointegrated The other stock market indices are not cointegrated with the German stock market index

22

Stock Market Integrationin Eastern Europe

The Stock Market

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

The Market Model

The Market ModelThe return on a common stock is assumed to be related to the return on a market index (eg FTSE100) in the following manner

(4)

where riI = return on security i for some given periodrI = return on market index for the same periodαiI = intercept termβiI = slope termεiI = random error term

iIIiIiIi rr ε+β+α=

The Stock Market 11

The International CAPM

International CAPME(ri ndash rh) = γ1Cov(rirw) + γ2Cov(ri ) (1)

ri return on security irw return on world market portfoliorh interest rate on domestic bonds

relative change of exchange rateγ1 and γ2 prices of the respective covariance risks

Problem with (1)γ1 and γ2 must be determined somehow

e

The Stock Market

amp

eamp

13

International CAPMrw and interest rate on foreign bonds are used as benchmarks

E(rw ndash rh) == (2)

+ rf ndash rh == (3)

+ rf expected return on foreign bonds (denominated in domesticcurrency)

The Stock Market

)eCov(rγ)rCov(rγ w2

ww1 amp+

)(eE amp)(eE amp

)e(ampE )eeCov(γ)reCov(γ 2w

1 ampampamp +)eVar(γ)reCov(γ 2

w1 ampamp +

)eCov(rγ)Var(rγ w2

w1 amp+

)e(ampE

14

International CAPMAssumptionfrom (2) and (3) resultrarr

(4)

(5)

(4) and (5) in (1)

The Stock Market

0)reCov( w =amp

)Var(rr)E(rγ w

hw

1minus

=

)eVar(rr)eE(γ

hf

2 ampamp minus+

=

15

International CAPM

(6)

β1 and β2 (sensitivity measures ) can be estimated as follows

ut ~ (0 σ2)

The Stock Market

)eCov(r)eVar(

)rreE()rCov(r)Var(r)rE(r)rE(r i

hfw

iw

hwh

i ampamp

ampsdot

minus++sdot

minus=minus

)rreE()eVar(

)eCov(r)rE(r)Var(r

)rCov(r hfihww

wi minus+sdot+minussdot= amp

ampamp

)rreE(β)rE(rβ hf2i

hw1i minus+sdot+minussdot= amp

t2iw1ii ueβrβαr +sdot+sdot+= amp

16

Technique employedCointegration Approach

SPit = α + βDAXt + ut (requirement α=0 β=1)

Eight Eastern European countries are considered ie Poland Czech Republic Slovenia and Hungary Estonia Lithuania Latvia and the Slovak Republic

The benchmark market is the German stock market (DAX is used as a proxy)

Monthly data are used covering the period from March 1995 to August 2008 except for Estonia (with the starting point August 1996) Lithuania (with the starting point February 2000) and Latvia (with the starting point March 2000)

17

Stock Market Integrationin Eastern Europe

The Stock Market

18

Stock Market Integrationin Eastern Europe

ytt00t zxbay ++=

xtt11t zybax ++=

(1)

(2)

yt

yn

1jjtyj

xn

1jjtxj

y1-tz

1t001tyy0t uyaxa)xbay(y +sum Δ+sum Δ+minusminusγminusγ=Δ

=minus

=minus

=

minusminus 444 3444 21

xt

n

1jjtyj

n

1jjtxj

z

1t001txx0t uΔybΔxb)xba(yγγΔx

yx

y1t

+++minusminus+= sumsum=

minus=

minus

=

minusminus

minus

444 3444 21

(3)

(4)

Cointegration Approach

The Stock Market

(5)

(6)

(trace-test)

tptp2t21t1t UYAYAYAY

19

Stock Market Integrationin Eastern Europe

++++= minusminusminus

t1pt

1p2t

21t

11tt UYAYAYAYY +Δ++Δ+Δ+Πminus=Δ +minusminusminusminusminus

summinus=Π=

p

1jjAI

1p 2 1j AAp

1jii

j minus=summinus=

+=

sum λminus=+=

k

1rii )ˆ1ln()r(Tr

The Stock Market

20

Stock Market Integrationin Eastern Europe

Series Germany-Czech Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 631767 154947 06580 At most 1 06407 38415 04235 Series Germany-Estonia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 143109 154947 00748 At most 1 31338 38415 00767 Series Germany-Hungary Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 169329 154947 00302 At most 1 28928 38415 00890 Series Germany-Latvia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 163184 154947 00375 At most 1 57756 38415 00162

The Stock Market

21

Stock Market Integrationin Eastern Europe

Series Germany-Lithuania Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 167550 154947 00322 At most 1 47125 38415 00299 Series Germany-Poland Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 118812 154947 01627 At most 1 25319 38415 01116 Series Germany-Slovak Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 64957 154947 06369 At most 1 00518 38415 08200 Series Germany-Slovenia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 42741 154947 08802 At most 1 02412 38415 06233 MacKinnon-Haug-Michelis (1999) p-values

The Stock Market

Result

Only the Hungarian stock market index and the German stock market index are cointegrated The other stock market indices are not cointegrated with the German stock market index

22

Stock Market Integrationin Eastern Europe

The Stock Market

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

The Market ModelThe return on a common stock is assumed to be related to the return on a market index (eg FTSE100) in the following manner

(4)

where riI = return on security i for some given periodrI = return on market index for the same periodαiI = intercept termβiI = slope termεiI = random error term

iIIiIiIi rr ε+β+α=

The Stock Market 11

The International CAPM

International CAPME(ri ndash rh) = γ1Cov(rirw) + γ2Cov(ri ) (1)

ri return on security irw return on world market portfoliorh interest rate on domestic bonds

relative change of exchange rateγ1 and γ2 prices of the respective covariance risks

Problem with (1)γ1 and γ2 must be determined somehow

e

The Stock Market

amp

eamp

13

International CAPMrw and interest rate on foreign bonds are used as benchmarks

E(rw ndash rh) == (2)

+ rf ndash rh == (3)

+ rf expected return on foreign bonds (denominated in domesticcurrency)

The Stock Market

)eCov(rγ)rCov(rγ w2

ww1 amp+

)(eE amp)(eE amp

)e(ampE )eeCov(γ)reCov(γ 2w

1 ampampamp +)eVar(γ)reCov(γ 2

w1 ampamp +

)eCov(rγ)Var(rγ w2

w1 amp+

)e(ampE

14

International CAPMAssumptionfrom (2) and (3) resultrarr

(4)

(5)

(4) and (5) in (1)

The Stock Market

0)reCov( w =amp

)Var(rr)E(rγ w

hw

1minus

=

)eVar(rr)eE(γ

hf

2 ampamp minus+

=

15

International CAPM

(6)

β1 and β2 (sensitivity measures ) can be estimated as follows

ut ~ (0 σ2)

The Stock Market

)eCov(r)eVar(

)rreE()rCov(r)Var(r)rE(r)rE(r i

hfw

iw

hwh

i ampamp

ampsdot

minus++sdot

minus=minus

)rreE()eVar(

)eCov(r)rE(r)Var(r

)rCov(r hfihww

wi minus+sdot+minussdot= amp

ampamp

)rreE(β)rE(rβ hf2i

hw1i minus+sdot+minussdot= amp

t2iw1ii ueβrβαr +sdot+sdot+= amp

16

Technique employedCointegration Approach

SPit = α + βDAXt + ut (requirement α=0 β=1)

Eight Eastern European countries are considered ie Poland Czech Republic Slovenia and Hungary Estonia Lithuania Latvia and the Slovak Republic

The benchmark market is the German stock market (DAX is used as a proxy)

Monthly data are used covering the period from March 1995 to August 2008 except for Estonia (with the starting point August 1996) Lithuania (with the starting point February 2000) and Latvia (with the starting point March 2000)

17

Stock Market Integrationin Eastern Europe

The Stock Market

18

Stock Market Integrationin Eastern Europe

ytt00t zxbay ++=

xtt11t zybax ++=

(1)

(2)

yt

yn

1jjtyj

xn

1jjtxj

y1-tz

1t001tyy0t uyaxa)xbay(y +sum Δ+sum Δ+minusminusγminusγ=Δ

=minus

=minus

=

minusminus 444 3444 21

xt

n

1jjtyj

n

1jjtxj

z

1t001txx0t uΔybΔxb)xba(yγγΔx

yx

y1t

+++minusminus+= sumsum=

minus=

minus

=

minusminus

minus

444 3444 21

(3)

(4)

Cointegration Approach

The Stock Market

(5)

(6)

(trace-test)

tptp2t21t1t UYAYAYAY

19

Stock Market Integrationin Eastern Europe

++++= minusminusminus

t1pt

1p2t

21t

11tt UYAYAYAYY +Δ++Δ+Δ+Πminus=Δ +minusminusminusminusminus

summinus=Π=

p

1jjAI

1p 2 1j AAp

1jii

j minus=summinus=

+=

sum λminus=+=

k

1rii )ˆ1ln()r(Tr

The Stock Market

20

Stock Market Integrationin Eastern Europe

Series Germany-Czech Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 631767 154947 06580 At most 1 06407 38415 04235 Series Germany-Estonia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 143109 154947 00748 At most 1 31338 38415 00767 Series Germany-Hungary Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 169329 154947 00302 At most 1 28928 38415 00890 Series Germany-Latvia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 163184 154947 00375 At most 1 57756 38415 00162

The Stock Market

21

Stock Market Integrationin Eastern Europe

Series Germany-Lithuania Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 167550 154947 00322 At most 1 47125 38415 00299 Series Germany-Poland Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 118812 154947 01627 At most 1 25319 38415 01116 Series Germany-Slovak Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 64957 154947 06369 At most 1 00518 38415 08200 Series Germany-Slovenia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 42741 154947 08802 At most 1 02412 38415 06233 MacKinnon-Haug-Michelis (1999) p-values

The Stock Market

Result

Only the Hungarian stock market index and the German stock market index are cointegrated The other stock market indices are not cointegrated with the German stock market index

22

Stock Market Integrationin Eastern Europe

The Stock Market

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

The International CAPM

International CAPME(ri ndash rh) = γ1Cov(rirw) + γ2Cov(ri ) (1)

ri return on security irw return on world market portfoliorh interest rate on domestic bonds

relative change of exchange rateγ1 and γ2 prices of the respective covariance risks

Problem with (1)γ1 and γ2 must be determined somehow

e

The Stock Market

amp

eamp

13

International CAPMrw and interest rate on foreign bonds are used as benchmarks

E(rw ndash rh) == (2)

+ rf ndash rh == (3)

+ rf expected return on foreign bonds (denominated in domesticcurrency)

The Stock Market

)eCov(rγ)rCov(rγ w2

ww1 amp+

)(eE amp)(eE amp

)e(ampE )eeCov(γ)reCov(γ 2w

1 ampampamp +)eVar(γ)reCov(γ 2

w1 ampamp +

)eCov(rγ)Var(rγ w2

w1 amp+

)e(ampE

14

International CAPMAssumptionfrom (2) and (3) resultrarr

(4)

(5)

(4) and (5) in (1)

The Stock Market

0)reCov( w =amp

)Var(rr)E(rγ w

hw

1minus

=

)eVar(rr)eE(γ

hf

2 ampamp minus+

=

15

International CAPM

(6)

β1 and β2 (sensitivity measures ) can be estimated as follows

ut ~ (0 σ2)

The Stock Market

)eCov(r)eVar(

)rreE()rCov(r)Var(r)rE(r)rE(r i

hfw

iw

hwh

i ampamp

ampsdot

minus++sdot

minus=minus

)rreE()eVar(

)eCov(r)rE(r)Var(r

)rCov(r hfihww

wi minus+sdot+minussdot= amp

ampamp

)rreE(β)rE(rβ hf2i

hw1i minus+sdot+minussdot= amp

t2iw1ii ueβrβαr +sdot+sdot+= amp

16

Technique employedCointegration Approach

SPit = α + βDAXt + ut (requirement α=0 β=1)

Eight Eastern European countries are considered ie Poland Czech Republic Slovenia and Hungary Estonia Lithuania Latvia and the Slovak Republic

The benchmark market is the German stock market (DAX is used as a proxy)

Monthly data are used covering the period from March 1995 to August 2008 except for Estonia (with the starting point August 1996) Lithuania (with the starting point February 2000) and Latvia (with the starting point March 2000)

17

Stock Market Integrationin Eastern Europe

The Stock Market

18

Stock Market Integrationin Eastern Europe

ytt00t zxbay ++=

xtt11t zybax ++=

(1)

(2)

yt

yn

1jjtyj

xn

1jjtxj

y1-tz

1t001tyy0t uyaxa)xbay(y +sum Δ+sum Δ+minusminusγminusγ=Δ

=minus

=minus

=

minusminus 444 3444 21

xt

n

1jjtyj

n

1jjtxj

z

1t001txx0t uΔybΔxb)xba(yγγΔx

yx

y1t

+++minusminus+= sumsum=

minus=

minus

=

minusminus

minus

444 3444 21

(3)

(4)

Cointegration Approach

The Stock Market

(5)

(6)

(trace-test)

tptp2t21t1t UYAYAYAY

19

Stock Market Integrationin Eastern Europe

++++= minusminusminus

t1pt

1p2t

21t

11tt UYAYAYAYY +Δ++Δ+Δ+Πminus=Δ +minusminusminusminusminus

summinus=Π=

p

1jjAI

1p 2 1j AAp

1jii

j minus=summinus=

+=

sum λminus=+=

k

1rii )ˆ1ln()r(Tr

The Stock Market

20

Stock Market Integrationin Eastern Europe

Series Germany-Czech Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 631767 154947 06580 At most 1 06407 38415 04235 Series Germany-Estonia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 143109 154947 00748 At most 1 31338 38415 00767 Series Germany-Hungary Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 169329 154947 00302 At most 1 28928 38415 00890 Series Germany-Latvia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 163184 154947 00375 At most 1 57756 38415 00162

The Stock Market

21

Stock Market Integrationin Eastern Europe

Series Germany-Lithuania Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 167550 154947 00322 At most 1 47125 38415 00299 Series Germany-Poland Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 118812 154947 01627 At most 1 25319 38415 01116 Series Germany-Slovak Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 64957 154947 06369 At most 1 00518 38415 08200 Series Germany-Slovenia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 42741 154947 08802 At most 1 02412 38415 06233 MacKinnon-Haug-Michelis (1999) p-values

The Stock Market

Result

Only the Hungarian stock market index and the German stock market index are cointegrated The other stock market indices are not cointegrated with the German stock market index

22

Stock Market Integrationin Eastern Europe

The Stock Market

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

International CAPME(ri ndash rh) = γ1Cov(rirw) + γ2Cov(ri ) (1)

ri return on security irw return on world market portfoliorh interest rate on domestic bonds

relative change of exchange rateγ1 and γ2 prices of the respective covariance risks

Problem with (1)γ1 and γ2 must be determined somehow

e

The Stock Market

amp

eamp

13

International CAPMrw and interest rate on foreign bonds are used as benchmarks

E(rw ndash rh) == (2)

+ rf ndash rh == (3)

+ rf expected return on foreign bonds (denominated in domesticcurrency)

The Stock Market

)eCov(rγ)rCov(rγ w2

ww1 amp+

)(eE amp)(eE amp

)e(ampE )eeCov(γ)reCov(γ 2w

1 ampampamp +)eVar(γ)reCov(γ 2

w1 ampamp +

)eCov(rγ)Var(rγ w2

w1 amp+

)e(ampE

14

International CAPMAssumptionfrom (2) and (3) resultrarr

(4)

(5)

(4) and (5) in (1)

The Stock Market

0)reCov( w =amp

)Var(rr)E(rγ w

hw

1minus

=

)eVar(rr)eE(γ

hf

2 ampamp minus+

=

15

International CAPM

(6)

β1 and β2 (sensitivity measures ) can be estimated as follows

ut ~ (0 σ2)

The Stock Market

)eCov(r)eVar(

)rreE()rCov(r)Var(r)rE(r)rE(r i

hfw

iw

hwh

i ampamp

ampsdot

minus++sdot

minus=minus

)rreE()eVar(

)eCov(r)rE(r)Var(r

)rCov(r hfihww

wi minus+sdot+minussdot= amp

ampamp

)rreE(β)rE(rβ hf2i

hw1i minus+sdot+minussdot= amp

t2iw1ii ueβrβαr +sdot+sdot+= amp

16

Technique employedCointegration Approach

SPit = α + βDAXt + ut (requirement α=0 β=1)

Eight Eastern European countries are considered ie Poland Czech Republic Slovenia and Hungary Estonia Lithuania Latvia and the Slovak Republic

The benchmark market is the German stock market (DAX is used as a proxy)

Monthly data are used covering the period from March 1995 to August 2008 except for Estonia (with the starting point August 1996) Lithuania (with the starting point February 2000) and Latvia (with the starting point March 2000)

17

Stock Market Integrationin Eastern Europe

The Stock Market

18

Stock Market Integrationin Eastern Europe

ytt00t zxbay ++=

xtt11t zybax ++=

(1)

(2)

yt

yn

1jjtyj

xn

1jjtxj

y1-tz

1t001tyy0t uyaxa)xbay(y +sum Δ+sum Δ+minusminusγminusγ=Δ

=minus

=minus

=

minusminus 444 3444 21

xt

n

1jjtyj

n

1jjtxj

z

1t001txx0t uΔybΔxb)xba(yγγΔx

yx

y1t

+++minusminus+= sumsum=

minus=

minus

=

minusminus

minus

444 3444 21

(3)

(4)

Cointegration Approach

The Stock Market

(5)

(6)

(trace-test)

tptp2t21t1t UYAYAYAY

19

Stock Market Integrationin Eastern Europe

++++= minusminusminus

t1pt

1p2t

21t

11tt UYAYAYAYY +Δ++Δ+Δ+Πminus=Δ +minusminusminusminusminus

summinus=Π=

p

1jjAI

1p 2 1j AAp

1jii

j minus=summinus=

+=

sum λminus=+=

k

1rii )ˆ1ln()r(Tr

The Stock Market

20

Stock Market Integrationin Eastern Europe

Series Germany-Czech Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 631767 154947 06580 At most 1 06407 38415 04235 Series Germany-Estonia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 143109 154947 00748 At most 1 31338 38415 00767 Series Germany-Hungary Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 169329 154947 00302 At most 1 28928 38415 00890 Series Germany-Latvia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 163184 154947 00375 At most 1 57756 38415 00162

The Stock Market

21

Stock Market Integrationin Eastern Europe

Series Germany-Lithuania Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 167550 154947 00322 At most 1 47125 38415 00299 Series Germany-Poland Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 118812 154947 01627 At most 1 25319 38415 01116 Series Germany-Slovak Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 64957 154947 06369 At most 1 00518 38415 08200 Series Germany-Slovenia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 42741 154947 08802 At most 1 02412 38415 06233 MacKinnon-Haug-Michelis (1999) p-values

The Stock Market

Result

Only the Hungarian stock market index and the German stock market index are cointegrated The other stock market indices are not cointegrated with the German stock market index

22

Stock Market Integrationin Eastern Europe

The Stock Market

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

International CAPMrw and interest rate on foreign bonds are used as benchmarks

E(rw ndash rh) == (2)

+ rf ndash rh == (3)

+ rf expected return on foreign bonds (denominated in domesticcurrency)

The Stock Market

)eCov(rγ)rCov(rγ w2

ww1 amp+

)(eE amp)(eE amp

)e(ampE )eeCov(γ)reCov(γ 2w

1 ampampamp +)eVar(γ)reCov(γ 2

w1 ampamp +

)eCov(rγ)Var(rγ w2

w1 amp+

)e(ampE

14

International CAPMAssumptionfrom (2) and (3) resultrarr

(4)

(5)

(4) and (5) in (1)

The Stock Market

0)reCov( w =amp

)Var(rr)E(rγ w

hw

1minus

=

)eVar(rr)eE(γ

hf

2 ampamp minus+

=

15

International CAPM

(6)

β1 and β2 (sensitivity measures ) can be estimated as follows

ut ~ (0 σ2)

The Stock Market

)eCov(r)eVar(

)rreE()rCov(r)Var(r)rE(r)rE(r i

hfw

iw

hwh

i ampamp

ampsdot

minus++sdot

minus=minus

)rreE()eVar(

)eCov(r)rE(r)Var(r

)rCov(r hfihww

wi minus+sdot+minussdot= amp

ampamp

)rreE(β)rE(rβ hf2i

hw1i minus+sdot+minussdot= amp

t2iw1ii ueβrβαr +sdot+sdot+= amp

16

Technique employedCointegration Approach

SPit = α + βDAXt + ut (requirement α=0 β=1)

Eight Eastern European countries are considered ie Poland Czech Republic Slovenia and Hungary Estonia Lithuania Latvia and the Slovak Republic

The benchmark market is the German stock market (DAX is used as a proxy)

Monthly data are used covering the period from March 1995 to August 2008 except for Estonia (with the starting point August 1996) Lithuania (with the starting point February 2000) and Latvia (with the starting point March 2000)

17

Stock Market Integrationin Eastern Europe

The Stock Market

18

Stock Market Integrationin Eastern Europe

ytt00t zxbay ++=

xtt11t zybax ++=

(1)

(2)

yt

yn

1jjtyj

xn

1jjtxj

y1-tz

1t001tyy0t uyaxa)xbay(y +sum Δ+sum Δ+minusminusγminusγ=Δ

=minus

=minus

=

minusminus 444 3444 21

xt

n

1jjtyj

n

1jjtxj

z

1t001txx0t uΔybΔxb)xba(yγγΔx

yx

y1t

+++minusminus+= sumsum=

minus=

minus

=

minusminus

minus

444 3444 21

(3)

(4)

Cointegration Approach

The Stock Market

(5)

(6)

(trace-test)

tptp2t21t1t UYAYAYAY

19

Stock Market Integrationin Eastern Europe

++++= minusminusminus

t1pt

1p2t

21t

11tt UYAYAYAYY +Δ++Δ+Δ+Πminus=Δ +minusminusminusminusminus

summinus=Π=

p

1jjAI

1p 2 1j AAp

1jii

j minus=summinus=

+=

sum λminus=+=

k

1rii )ˆ1ln()r(Tr

The Stock Market

20

Stock Market Integrationin Eastern Europe

Series Germany-Czech Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 631767 154947 06580 At most 1 06407 38415 04235 Series Germany-Estonia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 143109 154947 00748 At most 1 31338 38415 00767 Series Germany-Hungary Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 169329 154947 00302 At most 1 28928 38415 00890 Series Germany-Latvia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 163184 154947 00375 At most 1 57756 38415 00162

The Stock Market

21

Stock Market Integrationin Eastern Europe

Series Germany-Lithuania Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 167550 154947 00322 At most 1 47125 38415 00299 Series Germany-Poland Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 118812 154947 01627 At most 1 25319 38415 01116 Series Germany-Slovak Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 64957 154947 06369 At most 1 00518 38415 08200 Series Germany-Slovenia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 42741 154947 08802 At most 1 02412 38415 06233 MacKinnon-Haug-Michelis (1999) p-values

The Stock Market

Result

Only the Hungarian stock market index and the German stock market index are cointegrated The other stock market indices are not cointegrated with the German stock market index

22

Stock Market Integrationin Eastern Europe

The Stock Market

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

International CAPMAssumptionfrom (2) and (3) resultrarr

(4)

(5)

(4) and (5) in (1)

The Stock Market

0)reCov( w =amp

)Var(rr)E(rγ w

hw

1minus

=

)eVar(rr)eE(γ

hf

2 ampamp minus+

=

15

International CAPM

(6)

β1 and β2 (sensitivity measures ) can be estimated as follows

ut ~ (0 σ2)

The Stock Market

)eCov(r)eVar(

)rreE()rCov(r)Var(r)rE(r)rE(r i

hfw

iw

hwh

i ampamp

ampsdot

minus++sdot

minus=minus

)rreE()eVar(

)eCov(r)rE(r)Var(r

)rCov(r hfihww

wi minus+sdot+minussdot= amp

ampamp

)rreE(β)rE(rβ hf2i

hw1i minus+sdot+minussdot= amp

t2iw1ii ueβrβαr +sdot+sdot+= amp

16

Technique employedCointegration Approach

SPit = α + βDAXt + ut (requirement α=0 β=1)

Eight Eastern European countries are considered ie Poland Czech Republic Slovenia and Hungary Estonia Lithuania Latvia and the Slovak Republic

The benchmark market is the German stock market (DAX is used as a proxy)

Monthly data are used covering the period from March 1995 to August 2008 except for Estonia (with the starting point August 1996) Lithuania (with the starting point February 2000) and Latvia (with the starting point March 2000)

17

Stock Market Integrationin Eastern Europe

The Stock Market

18

Stock Market Integrationin Eastern Europe

ytt00t zxbay ++=

xtt11t zybax ++=

(1)

(2)

yt

yn

1jjtyj

xn

1jjtxj

y1-tz

1t001tyy0t uyaxa)xbay(y +sum Δ+sum Δ+minusminusγminusγ=Δ

=minus

=minus

=

minusminus 444 3444 21

xt

n

1jjtyj

n

1jjtxj

z

1t001txx0t uΔybΔxb)xba(yγγΔx

yx

y1t

+++minusminus+= sumsum=

minus=

minus

=

minusminus

minus

444 3444 21

(3)

(4)

Cointegration Approach

The Stock Market

(5)

(6)

(trace-test)

tptp2t21t1t UYAYAYAY

19

Stock Market Integrationin Eastern Europe

++++= minusminusminus

t1pt

1p2t

21t

11tt UYAYAYAYY +Δ++Δ+Δ+Πminus=Δ +minusminusminusminusminus

summinus=Π=

p

1jjAI

1p 2 1j AAp

1jii

j minus=summinus=

+=

sum λminus=+=

k

1rii )ˆ1ln()r(Tr

The Stock Market

20

Stock Market Integrationin Eastern Europe

Series Germany-Czech Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 631767 154947 06580 At most 1 06407 38415 04235 Series Germany-Estonia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 143109 154947 00748 At most 1 31338 38415 00767 Series Germany-Hungary Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 169329 154947 00302 At most 1 28928 38415 00890 Series Germany-Latvia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 163184 154947 00375 At most 1 57756 38415 00162

The Stock Market

21

Stock Market Integrationin Eastern Europe

Series Germany-Lithuania Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 167550 154947 00322 At most 1 47125 38415 00299 Series Germany-Poland Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 118812 154947 01627 At most 1 25319 38415 01116 Series Germany-Slovak Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 64957 154947 06369 At most 1 00518 38415 08200 Series Germany-Slovenia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 42741 154947 08802 At most 1 02412 38415 06233 MacKinnon-Haug-Michelis (1999) p-values

The Stock Market

Result

Only the Hungarian stock market index and the German stock market index are cointegrated The other stock market indices are not cointegrated with the German stock market index

22

Stock Market Integrationin Eastern Europe

The Stock Market

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

International CAPM

(6)

β1 and β2 (sensitivity measures ) can be estimated as follows

ut ~ (0 σ2)

The Stock Market

)eCov(r)eVar(

)rreE()rCov(r)Var(r)rE(r)rE(r i

hfw

iw

hwh

i ampamp

ampsdot

minus++sdot

minus=minus

)rreE()eVar(

)eCov(r)rE(r)Var(r

)rCov(r hfihww

wi minus+sdot+minussdot= amp

ampamp

)rreE(β)rE(rβ hf2i

hw1i minus+sdot+minussdot= amp

t2iw1ii ueβrβαr +sdot+sdot+= amp

16

Technique employedCointegration Approach

SPit = α + βDAXt + ut (requirement α=0 β=1)

Eight Eastern European countries are considered ie Poland Czech Republic Slovenia and Hungary Estonia Lithuania Latvia and the Slovak Republic

The benchmark market is the German stock market (DAX is used as a proxy)

Monthly data are used covering the period from March 1995 to August 2008 except for Estonia (with the starting point August 1996) Lithuania (with the starting point February 2000) and Latvia (with the starting point March 2000)

17

Stock Market Integrationin Eastern Europe

The Stock Market

18

Stock Market Integrationin Eastern Europe

ytt00t zxbay ++=

xtt11t zybax ++=

(1)

(2)

yt

yn

1jjtyj

xn

1jjtxj

y1-tz

1t001tyy0t uyaxa)xbay(y +sum Δ+sum Δ+minusminusγminusγ=Δ

=minus

=minus

=

minusminus 444 3444 21

xt

n

1jjtyj

n

1jjtxj

z

1t001txx0t uΔybΔxb)xba(yγγΔx

yx

y1t

+++minusminus+= sumsum=

minus=

minus

=

minusminus

minus

444 3444 21

(3)

(4)

Cointegration Approach

The Stock Market

(5)

(6)

(trace-test)

tptp2t21t1t UYAYAYAY

19

Stock Market Integrationin Eastern Europe

++++= minusminusminus

t1pt

1p2t

21t

11tt UYAYAYAYY +Δ++Δ+Δ+Πminus=Δ +minusminusminusminusminus

summinus=Π=

p

1jjAI

1p 2 1j AAp

1jii

j minus=summinus=

+=

sum λminus=+=

k

1rii )ˆ1ln()r(Tr

The Stock Market

20

Stock Market Integrationin Eastern Europe

Series Germany-Czech Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 631767 154947 06580 At most 1 06407 38415 04235 Series Germany-Estonia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 143109 154947 00748 At most 1 31338 38415 00767 Series Germany-Hungary Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 169329 154947 00302 At most 1 28928 38415 00890 Series Germany-Latvia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 163184 154947 00375 At most 1 57756 38415 00162

The Stock Market

21

Stock Market Integrationin Eastern Europe

Series Germany-Lithuania Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 167550 154947 00322 At most 1 47125 38415 00299 Series Germany-Poland Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 118812 154947 01627 At most 1 25319 38415 01116 Series Germany-Slovak Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 64957 154947 06369 At most 1 00518 38415 08200 Series Germany-Slovenia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 42741 154947 08802 At most 1 02412 38415 06233 MacKinnon-Haug-Michelis (1999) p-values

The Stock Market

Result

Only the Hungarian stock market index and the German stock market index are cointegrated The other stock market indices are not cointegrated with the German stock market index

22

Stock Market Integrationin Eastern Europe

The Stock Market

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Technique employedCointegration Approach

SPit = α + βDAXt + ut (requirement α=0 β=1)

Eight Eastern European countries are considered ie Poland Czech Republic Slovenia and Hungary Estonia Lithuania Latvia and the Slovak Republic

The benchmark market is the German stock market (DAX is used as a proxy)

Monthly data are used covering the period from March 1995 to August 2008 except for Estonia (with the starting point August 1996) Lithuania (with the starting point February 2000) and Latvia (with the starting point March 2000)

17

Stock Market Integrationin Eastern Europe

The Stock Market

18

Stock Market Integrationin Eastern Europe

ytt00t zxbay ++=

xtt11t zybax ++=

(1)

(2)

yt

yn

1jjtyj

xn

1jjtxj

y1-tz

1t001tyy0t uyaxa)xbay(y +sum Δ+sum Δ+minusminusγminusγ=Δ

=minus

=minus

=

minusminus 444 3444 21

xt

n

1jjtyj

n

1jjtxj

z

1t001txx0t uΔybΔxb)xba(yγγΔx

yx

y1t

+++minusminus+= sumsum=

minus=

minus

=

minusminus

minus

444 3444 21

(3)

(4)

Cointegration Approach

The Stock Market

(5)

(6)

(trace-test)

tptp2t21t1t UYAYAYAY

19

Stock Market Integrationin Eastern Europe

++++= minusminusminus

t1pt

1p2t

21t

11tt UYAYAYAYY +Δ++Δ+Δ+Πminus=Δ +minusminusminusminusminus

summinus=Π=

p

1jjAI

1p 2 1j AAp

1jii

j minus=summinus=

+=

sum λminus=+=

k

1rii )ˆ1ln()r(Tr

The Stock Market

20

Stock Market Integrationin Eastern Europe

Series Germany-Czech Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 631767 154947 06580 At most 1 06407 38415 04235 Series Germany-Estonia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 143109 154947 00748 At most 1 31338 38415 00767 Series Germany-Hungary Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 169329 154947 00302 At most 1 28928 38415 00890 Series Germany-Latvia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 163184 154947 00375 At most 1 57756 38415 00162

The Stock Market

21

Stock Market Integrationin Eastern Europe

Series Germany-Lithuania Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 167550 154947 00322 At most 1 47125 38415 00299 Series Germany-Poland Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 118812 154947 01627 At most 1 25319 38415 01116 Series Germany-Slovak Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 64957 154947 06369 At most 1 00518 38415 08200 Series Germany-Slovenia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 42741 154947 08802 At most 1 02412 38415 06233 MacKinnon-Haug-Michelis (1999) p-values

The Stock Market

Result

Only the Hungarian stock market index and the German stock market index are cointegrated The other stock market indices are not cointegrated with the German stock market index

22

Stock Market Integrationin Eastern Europe

The Stock Market

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

18

Stock Market Integrationin Eastern Europe

ytt00t zxbay ++=

xtt11t zybax ++=

(1)

(2)

yt

yn

1jjtyj

xn

1jjtxj

y1-tz

1t001tyy0t uyaxa)xbay(y +sum Δ+sum Δ+minusminusγminusγ=Δ

=minus

=minus

=

minusminus 444 3444 21

xt

n

1jjtyj

n

1jjtxj

z

1t001txx0t uΔybΔxb)xba(yγγΔx

yx

y1t

+++minusminus+= sumsum=

minus=

minus

=

minusminus

minus

444 3444 21

(3)

(4)

Cointegration Approach

The Stock Market

(5)

(6)

(trace-test)

tptp2t21t1t UYAYAYAY

19

Stock Market Integrationin Eastern Europe

++++= minusminusminus

t1pt

1p2t

21t

11tt UYAYAYAYY +Δ++Δ+Δ+Πminus=Δ +minusminusminusminusminus

summinus=Π=

p

1jjAI

1p 2 1j AAp

1jii

j minus=summinus=

+=

sum λminus=+=

k

1rii )ˆ1ln()r(Tr

The Stock Market

20

Stock Market Integrationin Eastern Europe

Series Germany-Czech Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 631767 154947 06580 At most 1 06407 38415 04235 Series Germany-Estonia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 143109 154947 00748 At most 1 31338 38415 00767 Series Germany-Hungary Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 169329 154947 00302 At most 1 28928 38415 00890 Series Germany-Latvia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 163184 154947 00375 At most 1 57756 38415 00162

The Stock Market

21

Stock Market Integrationin Eastern Europe

Series Germany-Lithuania Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 167550 154947 00322 At most 1 47125 38415 00299 Series Germany-Poland Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 118812 154947 01627 At most 1 25319 38415 01116 Series Germany-Slovak Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 64957 154947 06369 At most 1 00518 38415 08200 Series Germany-Slovenia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 42741 154947 08802 At most 1 02412 38415 06233 MacKinnon-Haug-Michelis (1999) p-values

The Stock Market

Result

Only the Hungarian stock market index and the German stock market index are cointegrated The other stock market indices are not cointegrated with the German stock market index

22

Stock Market Integrationin Eastern Europe

The Stock Market

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

(5)

(6)

(trace-test)

tptp2t21t1t UYAYAYAY

19

Stock Market Integrationin Eastern Europe

++++= minusminusminus

t1pt

1p2t

21t

11tt UYAYAYAYY +Δ++Δ+Δ+Πminus=Δ +minusminusminusminusminus

summinus=Π=

p

1jjAI

1p 2 1j AAp

1jii

j minus=summinus=

+=

sum λminus=+=

k

1rii )ˆ1ln()r(Tr

The Stock Market

20

Stock Market Integrationin Eastern Europe

Series Germany-Czech Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 631767 154947 06580 At most 1 06407 38415 04235 Series Germany-Estonia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 143109 154947 00748 At most 1 31338 38415 00767 Series Germany-Hungary Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 169329 154947 00302 At most 1 28928 38415 00890 Series Germany-Latvia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 163184 154947 00375 At most 1 57756 38415 00162

The Stock Market

21

Stock Market Integrationin Eastern Europe

Series Germany-Lithuania Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 167550 154947 00322 At most 1 47125 38415 00299 Series Germany-Poland Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 118812 154947 01627 At most 1 25319 38415 01116 Series Germany-Slovak Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 64957 154947 06369 At most 1 00518 38415 08200 Series Germany-Slovenia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 42741 154947 08802 At most 1 02412 38415 06233 MacKinnon-Haug-Michelis (1999) p-values

The Stock Market

Result

Only the Hungarian stock market index and the German stock market index are cointegrated The other stock market indices are not cointegrated with the German stock market index

22

Stock Market Integrationin Eastern Europe

The Stock Market

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

20

Stock Market Integrationin Eastern Europe

Series Germany-Czech Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 631767 154947 06580 At most 1 06407 38415 04235 Series Germany-Estonia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 143109 154947 00748 At most 1 31338 38415 00767 Series Germany-Hungary Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 169329 154947 00302 At most 1 28928 38415 00890 Series Germany-Latvia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 163184 154947 00375 At most 1 57756 38415 00162

The Stock Market

21

Stock Market Integrationin Eastern Europe

Series Germany-Lithuania Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 167550 154947 00322 At most 1 47125 38415 00299 Series Germany-Poland Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 118812 154947 01627 At most 1 25319 38415 01116 Series Germany-Slovak Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 64957 154947 06369 At most 1 00518 38415 08200 Series Germany-Slovenia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 42741 154947 08802 At most 1 02412 38415 06233 MacKinnon-Haug-Michelis (1999) p-values

The Stock Market

Result

Only the Hungarian stock market index and the German stock market index are cointegrated The other stock market indices are not cointegrated with the German stock market index

22

Stock Market Integrationin Eastern Europe

The Stock Market

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

21

Stock Market Integrationin Eastern Europe

Series Germany-Lithuania Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 167550 154947 00322 At most 1 47125 38415 00299 Series Germany-Poland Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 118812 154947 01627 At most 1 25319 38415 01116 Series Germany-Slovak Rep Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 64957 154947 06369 At most 1 00518 38415 08200 Series Germany-Slovenia Hypothesized No of CE(s) Trace Statistic 005 Critical Value ProbNone 42741 154947 08802 At most 1 02412 38415 06233 MacKinnon-Haug-Michelis (1999) p-values

The Stock Market

Result

Only the Hungarian stock market index and the German stock market index are cointegrated The other stock market indices are not cointegrated with the German stock market index

22

Stock Market Integrationin Eastern Europe

The Stock Market

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Result

Only the Hungarian stock market index and the German stock market index are cointegrated The other stock market indices are not cointegrated with the German stock market index

22

Stock Market Integrationin Eastern Europe

The Stock Market

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

23

Stock Market Integrationin Eastern Europe - Results

Country Constant Beta Adjusted R2 Theta Adjusted R2

Czech Rep )00380(

00290 )00730(

54860 05486 )07150(

68550 03773

Estonia )00072(

00116 )01326(

05854 01132 - -

Hungary )00047(

00125 )00904(

08527 03521 )00636(

08453 05397

Latvia )00072(

00174 )01375(

02933 00336 )00731(

01915 00477

Lithuania (00051)

00146 )00970(

03692 01157 01049(

03336 00619

Poland )00044(

00069 )00851(

06966 02897 )00583(

04541 02847

Slovak Rep )00045(

00076 )00849(

01299- 00082 )00517(

05601 04367

Slovenia )00046(

00091 )00874(

02005 00256 )00241(

00184 0

France

)00016(00002-

)00298(07869 08120

)01067(16385 06103

Portugal )00028(

00005- )00530(

07537 05539 )01067(

13171 05024

Significance at 1 level 5 level and 10 level respectively

The Stock Market

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

24

Stock Market Integrationin Eastern Europe

Czech Republic

-01

01

03

05

07

09

11

13

15

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Hungary

-010103050709111315

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Poland

00

02

04

06

08

10

12

14

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07 Slovenia

-02

00

02

04

06

08

10

12

97M

07

98M

07

99M

07

00M

07

01M

07

02M

07

03M

07

04M

07

05M

07

06M

07

07M

07

08M

07

09M

07

Time-varying beta

The Stock Market

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Stock Market Integration in Europe

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Stock Market Integration in Europe

The Stock Market 26

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Stock Market Integration in Europe

The Stock Market 27

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Stock Market Integration in Europe

The Stock Market 28

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Stock Market Integration in Europe

The Stock Market 29

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Stock Market Integration in Europe

The Stock Market 30

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Stock Market Integration in Europe

The Stock Market 31

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Stock Market Integration in Europe

The Stock Market 32

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Stock Market Integration in Europe

The Stock Market 33

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Bond Market (Integration)

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Introduction

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Bonds are issued by governments or by firmsIf issued by the government or government agencies the bonds are called government bonds

If issued by firms (corporations) they are called corporate bonds

Bonds are traded in securities markets this distinguishes from bank debt ndash claims held by banks cannot in general be sold to a third party

Bonds are rated for their default risk (the risk that the issuer of the bond will not pay back the full amount promised by the bond)

A lower rating typically implies that the bond has to pay a higher interest rate or else investors will not buy it

Introduction

The Bond Market 36

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

The difference between the interest rate paid on a given bond and the interest rate paid on the bond with the highest (best) rating is called the risk premium associated with the given bond

Bonds with high default risk are sometimes called junk bonds

Bonds that promise a single payment at maturity are called discount bonds The single payment is called the face value of the bond

Introduction

The Bond Market 37

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Introduction

The Bond Market 38

Interest Rates (in )

2

3

4

5

6

7

8

9

10

11

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Germany Poland SloveniaHungary Czech Rep

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Introduction

The Bond Market 39

Interest Rate Spreads (10y bonds in )

-1

1

2

3

4

5

6

7

8

9

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Poland Slovenia Hungary Czech Rep

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Introduction

The Bond Market 40

Interest Rate Spreads (10y bonds in )

-1

2

4

6

8

10

12

M1

01

M1

02

M1

03

M1

04

M1

05

M1

06

M1

07

M1

08

M1

09

M1

10

Lithuania Latvia Estonia Slovak Rep

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Bonds that promise multiple payments before maturity and one payment at maturity are called coupon bonds

The payments before maturity are called coupon payments

The final payment is called the face value of the bond

The ratio of coupon payments to the face value is called the coupon rate

The current yield is the ratio of the coupon payment to the price of the bond

Introduction

The Bond Market 41

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Example

A bond with coupon payments of $5 each year a face value of $100 and a price of $80 has a coupon rate of 5 and a current yield of 580 = 00625 = 625

Introduction

The Bond Market 42

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Bonds with a maturity of up to 1 year are called Treasury bills or T-bills They are discount bonds making only one payment at maturity

Bonds with a maturity of 1 to 10 years when they are issued are called Treasury bonds Treasury bonds are coupon bonds

There are also other types of bonds

Indexed bondsBonds that promise payments adjusted for inflation rather than fixed nominal payments

Instead of promising to pay say 100 dollars in a year a 1-year indexed bond promises to pay 100(1 + π) dollars π is the rate of inflation

Introduction

The Bond Market 43

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Bonds differ in two basic dimensions Default riskMaturity the length of time over which the bond promises to make payments to the holder of the bond (1 year 5 years 10 years)

Bonds of different maturities each have a price and an associated interest rate called the yield to maturity or simply the yield

Yields on bonds with a short maturity typically a year or less are called short-term interest rates Yields on bonds with longer maturity are called long-term interest rates

Introduction

The Bond Market 44

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Prices Yields andInterest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Because we value the cash paid to us tomorrow less than the cash that is in our pocket today we will discount those future receipts of cash that a bond entitles us to

The yield on a bond is simply the rate of return that when used to discount future cash receipts makes their total value equal to the current market price of the bond

Prices Yields andInterest Rates

The Bond Market 46

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

where C is the regular annual coupon payment on the bond and F is the face value

The bond matures n years from now

Prices Yields andInterest Rates

The Bond Market

nnB iF

iC

iC

iCP

)1()1(

)1(1 2 ++

+++

++

+=

47

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Prices Yields andInterest Rates

The Bond Market

Yield to maturity

Bond Price

48

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

The yield to maturity is a measure of the average rate of return a buyer will earn on a bond if the buyer holds it to maturity

Prices Yields andInterest Rates

The Bond Market 49

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Yield Curves

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Interest RatesInterest Rates on German Government Bonds with Different Maturities (M Q Y)

0

1

2

3

4

5

6

7

8

9

10

Jun

86

Jun

88

Jun

90

Jun

92

Jun

94

Jun

96

Jun

98

Jun

00

Jun

02

Jun

04

Jun

06

1 year maturity 5 years maturity 10 years maturity

Data Source Deutsche Bundesbank

Interest Rate ()

51The Bond Market

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Yield Curves

Upward Sloping Flat Downward Sloping Yield

Maturity Maturity Maturity

Yield Yield

The Bond Market 52

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

A plot of the yields on default-free government bonds with differing terms to maturity is called a yield curve and it represents the term structure of interest rates for the government bonds

Typically the yield curve is upward sloping but at times it is flat or downward sloping

Yield Curves

The Bond Market 53

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Yield Curve (Germany)

Upward Sloping (June 1997)

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

54The Bond Market

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Yield Curve (Germany)

Flat (October 1988)

0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

55The Bond Market

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Yield Curve (Germany)

Downward Sloping (February 1992)

65

7

75

8

85

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Yield (in )

Data Source Deutsche Bundesbank Maturity

56The Bond Market

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

3

35

93m01 95m01 97m01 99m01 01m01 03m01 05m01 07m01

EU15 = 1IrelandSpainPortugalGreece

Yiel

ds (

)

Data Source Eurostat

Yie

lds

57

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Interest Rates

The Bond Market

Long-Term Interest Rates in Selected EU Countries (M Q Y)

05

1

15

2

25

01m01 03m01 05m01 07m01

EU15 = 1HUNPolandSlovakia

Yie

lds

()

Data Source Eurostat

Yie

lds

58

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates

Thank you for your attention

59

• Financial Market Integration
• Outline
• Stock Market Integration
• The Capital Asset Pricing Model
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Capital Asset Pricing Model (CAPM)
• The Market Model
• The Market Model
• The International CAPM
• International CAPM
• International CAPM
• International CAPM
• International CAPM
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Stock Market Integration in Europe
• Bond Market (Integration)
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Introduction
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Prices Yields andInterest Rates
• Yield Curves
• Interest Rates
• Yield Curves
• Yield Curves
• Yield Curve (Germany)
• Yield Curve (Germany)
• Yield Curve (Germany)
• Interest Rates
• Interest Rates