This article appeared on the WSJ Internet site on Oct. 3. Assuming that the article was responding to current information, what do you think the WSJ was reporting regarding the stock market at that time on Oct. 3? Use the information in the article and the theories described in class to explain your answer. Your answer will be evaluated in the context of how well you use the information in the article and the understanding of the theories of interest rate determination that you demonstrate. Other than that, it is irrelevant as to whether you actually remember what the stock market did on Oct. 3.
Ans: The following points are relevant:
One factor heightening worries about price pressures Monday, bond strategists
said, was the prices-paid component of the National Association of Purchasing
business index. The main index rose to 49.9 from 49.5 in August; readings below 50 indicate a
contraction of manufacturing activity.
This suggests that manufacturing activity went up even though the index still remains below 50.
Mr. Flanagan of Morgan Stanley Dean Witter said that depending on
whether the next batch of first-tier economic data -- most notably the
September U.S. employment report slated for release Friday -- confirm the
U.S. economy is slowing, the yields of short-dated Treasurys could then fall
below those of the long bond.
This suggests that corporate cashflow estimates probably aren't going up to any great extent, if at all.
Soaring crude-oil prices that reignited worries about inflation in the
U.S. sent the bond market mostly lower ahead of Tuesday's Federal Reserve
policy makers' meeting, at which no shift in interest rates is expected.
This seems to indicate uncertainty.
This sentiment was driven Monday in part by uncertainty about violence
on the West Bank and the Gaza Strip, which Ms. Wright said is "on the
[bond] market's horizon." However, she added, "no one knows how
extensive it is, or how to assess it yet," in terms of the possible
longer-term impact on crude-oil prices.
This very clearly indicates uncertainty.
The totality of the article indicates that the risk-free rate has increased; the level of uncertainty has increased as well. Consequently, the market risk premium probably went up as well. The required rate of return on stocks therefore must have gone up. On the other hand, there is no reason to believe that corporate cashflow estimates went up, either. Consequently, there is no reason to believe that the stock market went in the opposite direction to the bond market. Hence the stock market as a whole must have dropped.
Treasury Quotes as of midafternoon Friday, October 6, 2000 from the WSJ. Keep in mind that these rates are valid for immediate, with one day allowed for settlement (however, given that Monday is Yom Kippur and the markets are closed, settlement will take place on Tuesday).
|Oct 12 '00||2||5.99||5.91|
|Oct 19 '00||9||5.83||5.75|
|Oct 26 '00||16||5.89||5.81|
|Nov 02 '00||23||5.92||5.84|
|Nov 09 '00||30||5.94||5.90|
|Nov 16 '00||37||5.92||5.88|
Money Rates For Friday, October 6 (assume these are also midafternoon rates). (also from the WSJ Internet edition)
COMMERCIAL PAPER: placed directly by General Electric Capital Corp.: 6.48% 30 to 37 days; 6.46% 38 to 67 days; 6.43% 68 to 96 days; 6.51% 97 to 121 days; 6.46% 122 to 160 days; 6.41% 161 to 201 days; 6.36% 202 to 239 days; 6.33% 240 to 270 days.
Suppose you have a million dollars to invest as of midafternoon Friday, Oct. 3, 2000 . You wish to invest those million dollars for 37 days. How much would you have on hand at the end of 37 days, if you invest in GEC Corp. commercial paper. (Assume that commercial paper rates are quoted in bank-equivalent yields, and are ask quotes, and that Treasury quotes are banker's discount.)