1
00:00:00,000 --> 00:00:08,000
Alan Cring Productions in association with the Emergent Light Studio presents

2
00:00:08,000 --> 00:00:17,000
the Illinois State Collegiate Compendium, Academic Lectures in Business and Economics.

3
00:00:17,000 --> 00:00:24,000
This is Business Finance, FIL 240 for spring semester 2024.

4
00:00:24,000 --> 00:00:44,000
Today, bonds and yields. Just a quick look at the numbers for the day so we can see what's going on here and then move on with the fun of the lecture.

5
00:00:44,000 --> 00:00:54,000
Unmute this. There we go.

6
00:00:54,000 --> 00:01:15,000
So as you can see, this is a slightly bare day but it's not really showing much signs of activity. Overall, as far as momentum one way or the other, it's kind of flat.

7
00:01:15,000 --> 00:01:27,000
You can see that the Dow is down a lousy 0.01% which means really nothing and the S&P 500 is down a little more.

8
00:01:27,000 --> 00:01:40,000
But oddly, the NASDAQ has been bouncing up and down on good and bad news as the bears and bulls pull and fight against each other.

9
00:01:40,000 --> 00:01:52,000
There's not really much you can say about this. As you can see right now, the bears are sort of winning, dragging the indexes and the exchange down.

10
00:01:52,000 --> 00:01:56,000
But what you can say from there, you can't really say a whole lot.

11
00:01:56,000 --> 00:02:05,000
Oil had made a run upward and then in the last maybe 30-45 minutes, it's finally beginning to pull back.

12
00:02:05,000 --> 00:02:12,000
It's still in that trading range so no chance of giant spikes in gas prices for the time being.

13
00:02:12,000 --> 00:02:25,000
Interestingly, gold is down and that's good news. That simply means that the markets aren't panicking about anything and running to gold.

14
00:02:25,000 --> 00:02:37,000
Silver is similarly down too. But going over here really quick, the bond market, the prices, the yields were rising which means prices were falling.

15
00:02:37,000 --> 00:02:41,000
That's all good news and we can all celebrate that. Yay.

16
00:02:41,000 --> 00:02:50,000
But at the same time, the yields are up so for what that's worth, that means that prices are down.

17
00:02:50,000 --> 00:02:56,000
There's selling in the bond market. There's also of course selling in the equities market too.

18
00:02:56,000 --> 00:03:10,000
And the money isn't going into gold so that means that the money is just being pulled off the playing field for more indication later about where we are actually headed with the economy.

19
00:03:10,000 --> 00:03:24,000
And it wasn't a good day over. Well, Nikkei was up for the day but as you can see it started running up during the morning over in Tokyo but then it kind of just slowly slid back.

20
00:03:24,000 --> 00:03:34,000
It still finished up but not much. London was just finished closing a while ago and it was down for the day.

21
00:03:34,000 --> 00:03:45,000
I don't know what that was about but there's political issues over in England that probably don't translate much into world issues.

22
00:03:45,000 --> 00:03:52,000
So what was happening over there was just a British thing for the day.

23
00:03:52,000 --> 00:04:00,000
Now I'm going to take you on a little bit of a journey here very quickly.

24
00:04:00,000 --> 00:04:09,000
As far as the Chapter 7 goes, I will not ask math questions about Chapter 7 on the midterm.

25
00:04:09,000 --> 00:04:15,000
We've got one more day of lecture after this. I'll do some of the math with you.

26
00:04:15,000 --> 00:04:27,000
But as far as the actual questions from Chapter 7 that could be on the midterm, they would be more like definitions and words and terms.

27
00:04:27,000 --> 00:04:35,000
Nothing that would have you pulling up calculators or Excel spreadsheets on the specifics of Chapter 7.

28
00:04:35,000 --> 00:04:39,000
So that you should celebrate that as a happy news.

29
00:04:39,000 --> 00:04:45,000
But at the same time there are other issues that we can bring up here from Chapter 7.

30
00:04:45,000 --> 00:05:02,000
Now what I'm going to do here, at least for the first part of this, is to sort of work across Chapters 5, 6, and 7 and bring up a couple of different issues that would be useful for you on the exam.

31
00:05:02,000 --> 00:05:20,000
And I've even improved an Excel sheet that you already have so that you can successfully navigate some of the problems that you would have on the exam.

32
00:05:20,000 --> 00:05:33,000
First things first, let me take this off the board here for a few minutes and put this down, let it quiet down for a little while.

33
00:05:33,000 --> 00:05:35,000
Let me do something here.

34
00:05:35,000 --> 00:05:44,000
As I said earlier, different words mean pretty much the same thing as far as interest rates go.

35
00:05:44,000 --> 00:05:54,000
Yield, return, rate, those all are interest rates, they're all percentage.

36
00:05:54,000 --> 00:06:00,000
And we use just a different term for different types of financial investments.

37
00:06:00,000 --> 00:06:10,000
But very quickly here, a yield, let's do a return.

38
00:06:10,000 --> 00:06:14,000
Let me start it out like this.

39
00:06:14,000 --> 00:06:33,000
You sir, you make an investment of $100 and in one now, and in one year, you have $110.

40
00:06:33,000 --> 00:06:58,000
Now, the holding period return, the HPR, I think the book calls it, I'm not sure, is nothing but the ending value over the beginning value minus 1.

41
00:06:58,000 --> 00:07:02,000
That's all holding period return is, HPR.

42
00:07:02,000 --> 00:07:16,000
So the HPR on this investment is 110 over 100 minus 1, which would be 10%.

43
00:07:16,000 --> 00:07:20,000
Nothing hard about that.

44
00:07:20,000 --> 00:07:41,000
But you sir, now you put in $100 and in six months, you have $110.

45
00:07:41,000 --> 00:07:55,000
So your HPR is also 110 over 100 minus 1, which is 10%.

46
00:07:55,000 --> 00:08:03,000
But those can't be the end of the story because it took you only six months to do what took him a year to do.

47
00:08:03,000 --> 00:08:17,000
That's why we need to make all of the units for calculations of yields, returns, rates, whatever, we need to have them in the same units.

48
00:08:17,000 --> 00:08:22,000
That's where we come to the concept of annualization.

49
00:08:22,000 --> 00:08:42,000
Annualizing returns, so the annualized return would make everything based on a year, APR, annual percentage rate.

50
00:08:42,000 --> 00:08:46,000
That's why you see that A in the APR.

51
00:08:46,000 --> 00:08:50,000
We make everything this way.

52
00:08:50,000 --> 00:09:05,000
The ending value over the beginning value to the 1 over the number of years minus 1.

53
00:09:05,000 --> 00:09:08,000
Don't forget that minus 1 for heaven's sakes.

54
00:09:08,000 --> 00:09:20,000
As you can see, the holding period return is the annual if it's a one-year hold because that would be to the 1 over one year.

55
00:09:20,000 --> 00:09:24,000
But this one, I would have to do something else.

56
00:09:24,000 --> 00:09:40,000
The annualized return would be 110 over 100 to the 1 over a half a year, 1 over.5 year minus 1.

57
00:09:40,000 --> 00:09:42,000
You have to take a 1 over the number of years.

58
00:09:42,000 --> 00:09:50,000
Now, I have modified that spreadsheet that you have for present values and future values,

59
00:09:50,000 --> 00:09:56,000
and I put a new worksheet on there that will do this calculation really fast.

60
00:09:56,000 --> 00:10:02,000
But if I work this out on a calculator, it will come up to be 21%.

61
00:10:02,000 --> 00:10:14,000
So that's where we see that your six-month investment dominated the one year the get got the same HPR.

62
00:10:14,000 --> 00:10:18,000
The HPR doesn't tell us anything, really.

63
00:10:18,000 --> 00:10:27,000
It's that annualized rate that does the leg work.

64
00:10:27,000 --> 00:10:31,000
There are a couple of things you have to watch in this.

65
00:10:31,000 --> 00:10:35,000
I'm going to do this one, that one that you just saw there on the calculator,

66
00:10:35,000 --> 00:10:45,000
just to make sure you see if you want to use the calculator to do an annualized rate of return.

67
00:10:45,000 --> 00:10:46,000
Okay, watch.

68
00:10:46,000 --> 00:10:52,000
Now, on this one, I'm going to do that second one again.

69
00:10:52,000 --> 00:10:55,000
I'm going to do open parenthesis.

70
00:10:55,000 --> 00:11:04,000
You're going to do the ending value divided by the beginning value, 110 divided by 100.

71
00:11:04,000 --> 00:11:06,000
Close the parentheses.

72
00:11:06,000 --> 00:11:08,000
Now, use the exponent.

73
00:11:08,000 --> 00:11:11,000
Now, the exponent you have to put in parentheses.

74
00:11:11,000 --> 00:11:13,000
Watch that.

75
00:11:13,000 --> 00:11:17,000
That's where I always, well, that's one of the places I screw up.

76
00:11:17,000 --> 00:11:22,000
It's one open parenthesis, one divided by the.5.

77
00:11:22,000 --> 00:11:26,000
Close the parenthesis, and then don't forget the minus one.

78
00:11:26,000 --> 00:11:35,000
This is one of those where if you forget the minus one, what comes out will look like a good answer.

79
00:11:35,000 --> 00:11:36,000
Watch it.

80
00:11:36,000 --> 00:11:41,000
That's a classic mistake, and you'll see me even forget the,

81
00:11:41,000 --> 00:11:46,000
I go through all that exponent stuff in the parentheses, and I forget the minus one.

82
00:11:46,000 --> 00:11:47,000
There we go.

83
00:11:47,000 --> 00:11:54,000
There's the 21%.

84
00:11:54,000 --> 00:11:58,000
Now, let me show you what I've done for you in Excel.

85
00:11:58,000 --> 00:12:02,000
This is that spreadsheet that you have, that you've downloaded.

86
00:12:02,000 --> 00:12:07,000
Now, you'll want to download the new version of it, because I put a new worksheet in there,

87
00:12:07,000 --> 00:12:13,000
annualizing, and I've done this.

88
00:12:13,000 --> 00:12:16,000
Beginning amount, 100.

89
00:12:16,000 --> 00:12:24,000
Ending amount, 110, for.5 years.

90
00:12:24,000 --> 00:12:27,000
There you go.

91
00:12:27,000 --> 00:12:29,000
That fast.

92
00:12:29,000 --> 00:12:31,000
Now, this is one thing.

93
00:12:31,000 --> 00:12:33,000
The calculator could have done that fairly quickly.

94
00:12:33,000 --> 00:12:56,000
However, suppose you buy a stock for $17.81,

95
00:12:56,000 --> 00:13:20,000
and you sell it in three years for $19.97.

96
00:13:20,000 --> 00:13:26,000
Let's annualize the return on it, just in the Excel spreadsheet.

97
00:13:26,000 --> 00:13:40,000
All you do is put in the $17.81, and then you go down, and you end $19.97,

98
00:13:40,000 --> 00:13:45,000
and your holding period is three years.

99
00:13:45,000 --> 00:13:48,000
That little trick with the units, I'll show you how to do that later.

100
00:13:48,000 --> 00:13:52,000
It's really a convenience.

101
00:13:52,000 --> 00:13:57,000
There's your annualized rate of return, 3.89.

102
00:13:57,000 --> 00:14:00,000
That fast.

103
00:14:00,000 --> 00:14:05,000
Now, that's a pretty thing right there, because that saves you having to do it on a calculator,

104
00:14:05,000 --> 00:14:12,000
and it looks on the midterm, I will ask you a question just like this.

105
00:14:12,000 --> 00:14:19,000
And you can look like a hero, because it just spits out if you just put the numbers in,

106
00:14:19,000 --> 00:14:23,000
where they belong, out will pop your answer.

107
00:14:23,000 --> 00:14:33,000
Now, as you can see, I've also done a version of this for days instead of years.

108
00:14:33,000 --> 00:14:37,000
Now, I could have done this a little more sophisticated,

109
00:14:37,000 --> 00:14:43,000
but Excel has a way to do days between two dates.

110
00:14:43,000 --> 00:14:54,000
But let's just do one.

111
00:14:54,000 --> 00:15:11,000
You buy a stock on March 18, 2021,

112
00:15:11,000 --> 00:15:30,000
and you sell it on October 8, 2023.

113
00:15:30,000 --> 00:15:48,000
You bought it at $32.32 and 84 cents,

114
00:15:48,000 --> 00:16:07,000
and you sold it at $34.90.

115
00:16:07,000 --> 00:16:10,000
So here you don't have the days.

116
00:16:10,000 --> 00:16:13,000
Now, like I said, you can do this in Excel.

117
00:16:13,000 --> 00:16:18,000
I didn't do it in Excel, but it's not that hard to find the number of days.

118
00:16:18,000 --> 00:16:22,000
Watch.

119
00:16:22,000 --> 00:16:27,000
Even your calculator, your TI can do it, but I'll show you.

120
00:16:27,000 --> 00:16:33,000
Go over here, and the way I do it, if I just need some days between dates,

121
00:16:33,000 --> 00:16:42,000
Google days between dates, date calculator.

122
00:16:42,000 --> 00:16:45,000
You put in the start date.

123
00:16:45,000 --> 00:16:54,000
The month was March.

124
00:16:54,000 --> 00:17:09,000
The day was what? The 18th year was 2021.

125
00:17:09,000 --> 00:17:18,000
Now you ended it on October, so that would be the day,

126
00:17:18,000 --> 00:17:28,000
what day did you do it? 8th of 2023.

127
00:17:28,000 --> 00:17:32,000
Now just calculate it.

128
00:17:32,000 --> 00:17:37,000
That's 934 days.

129
00:17:37,000 --> 00:17:41,000
So now you just go back to Excel.

130
00:17:41,000 --> 00:17:46,000
You began with $32.84.

131
00:17:46,000 --> 00:17:55,000
You ended with $34.90.

132
00:17:55,000 --> 00:17:59,000
And it was what? What did that say?

133
00:17:59,000 --> 00:18:05,000
934 days.

134
00:18:05,000 --> 00:18:13,000
There's your annualized rate, 2.41%.

135
00:18:13,000 --> 00:18:21,000
Like I said, you can do it in Excel, but I didn't write the code for that one.

136
00:18:21,000 --> 00:18:38,000
But what you're actually doing there in that formula is you're doing end over beginning

137
00:18:38,000 --> 00:18:52,000
to the one over the number of days over 365 minus one.

138
00:18:52,000 --> 00:18:56,000
You're turning the days into decimal years.

139
00:18:56,000 --> 00:19:01,000
And as you can see, if you look at the formula, see right here in the formula,

140
00:19:01,000 --> 00:19:06,000
I've got end over beginning, D3 over D2, and then I have the one over,

141
00:19:06,000 --> 00:19:15,000
and then it's taking the number of days that are in cell D4 and dividing it by 365

142
00:19:15,000 --> 00:19:25,000
to turn it into, what would that be, like 2.4 years, something like that.

143
00:19:25,000 --> 00:19:35,000
So the formula needs to be in years or parts of years, years end or parts of years.

144
00:19:35,000 --> 00:19:39,000
And that's how it comes out with that answer.

145
00:19:39,000 --> 00:19:44,000
You can do that on the calculator, but I have found over the years that students have a hard time,

146
00:19:44,000 --> 00:19:49,000
especially on the pressure of an exam, trying to pull off that,

147
00:19:49,000 --> 00:19:53,000
keep everything in the parentheses as you're running it along.

148
00:19:53,000 --> 00:19:56,000
And it can come out to be a fiasco.

149
00:19:56,000 --> 00:20:01,000
But this way, it spits out cleanly for you.

150
00:20:01,000 --> 00:20:07,000
The only thing with this one is you do have to find a resource that will give you the number of days.

151
00:20:07,000 --> 00:20:11,000
Now, on an exam, I would give you years.

152
00:20:11,000 --> 00:20:15,000
I wouldn't make it so that it was days, parts of a year.

153
00:20:15,000 --> 00:20:19,000
So it would just be four years, eight years, something like that.

154
00:20:19,000 --> 00:20:22,000
So it would work out better for you.

155
00:20:22,000 --> 00:20:38,000
I'll show you something real quick here, if I can find it.

156
00:20:38,000 --> 00:20:40,000
Well, let me do this.

157
00:20:40,000 --> 00:20:44,000
And I'll come back to this chart a little later in the course.

158
00:20:44,000 --> 00:20:45,000
Try this.

159
00:20:45,000 --> 00:20:51,000
Historical stock market returns.

160
00:20:51,000 --> 00:21:00,000
I'm looking for one stock one, if I am finding it.

161
00:21:00,000 --> 00:21:03,000
Slick charts now, come on.

162
00:21:03,000 --> 00:21:07,000
If I am finding it, it's useful to know.

163
00:21:07,000 --> 00:21:13,000
Let me try this.

164
00:21:13,000 --> 00:21:19,000
One stock one.

165
00:21:19,000 --> 00:21:23,000
Historical returns.

166
00:21:23,000 --> 00:21:25,000
I'll grab one here.

167
00:21:25,000 --> 00:21:32,000
Let me look at, for example, the S&P 500.

168
00:21:32,000 --> 00:21:39,000
This would be in 1975.

169
00:21:39,000 --> 00:21:47,000
If you had put $68.56 into the S&P 500 in 1975.

170
00:21:47,000 --> 00:21:55,000
Now, this takes us clear down to 2023.

171
00:21:55,000 --> 00:22:04,000
So 1975 to 2023 is 25, and 23 is 48 years.

172
00:22:04,000 --> 00:22:08,000
Watch.

173
00:22:08,000 --> 00:22:11,000
So the beginning amount was what?

174
00:22:11,000 --> 00:22:16,000
$68.56.

175
00:22:16,000 --> 00:22:24,000
The ending value was, what am I looking at here?

176
00:22:24,000 --> 00:22:29,000
$38.3950.

177
00:22:29,000 --> 00:22:33,000
$38.3950.

178
00:22:33,000 --> 00:22:38,000
And that would have been, what did I say, 28 years?

179
00:22:38,000 --> 00:22:43,000
75, 20, yeah, that would be 48 years.

180
00:22:43,000 --> 00:22:52,000
Let's see what the annual, if you had just put that money in and left it there.

181
00:22:52,000 --> 00:23:01,000
You would have made an annualized return over that long period of time of 8 3.25%.

182
00:23:01,000 --> 00:23:10,000
In other words, if you had just not touched it, just even in the black swans, you leave it alone, just ride it.

183
00:23:10,000 --> 00:23:17,000
Your annualized return over that period of time would have been 8 3.25%.

184
00:23:17,000 --> 00:23:26,000
Which when you look at it from the perspective of a long-term investment, you couldn't have gotten that in a CD, a 48-year CD.

185
00:23:26,000 --> 00:23:33,000
You couldn't have gotten that in a bank account if you had just left that stupid money alone.

186
00:23:33,000 --> 00:23:39,000
You would have gotten a return of 8.75%.

187
00:23:39,000 --> 00:23:46,000
So that's something that is useful to know, is that you can calculate on an annualized basis,

188
00:23:46,000 --> 00:23:52,000
and you can compare it to shorter investments all along the way.

189
00:23:52,000 --> 00:23:57,000
This is what this can do for you.

190
00:23:57,000 --> 00:24:01,000
So that's there for you now, it's in your files.

191
00:24:01,000 --> 00:24:13,000
You don't want to do that, but it happens.

192
00:24:13,000 --> 00:24:19,000
I was at a stupid graduation ceremony, I forgot to turn it off,

193
00:24:19,000 --> 00:24:25,000
and I didn't realize my dear daughter had put a new ringtone on it.

194
00:24:25,000 --> 00:24:31,000
Boy, was that embarrassing.

195
00:24:31,000 --> 00:24:36,000
I sent her a text message about what kind of depth she was going to have.

196
00:24:36,000 --> 00:24:44,000
Okay, anyway, so there's that.

197
00:24:44,000 --> 00:25:02,000
Okay, so now the next thing that I want to do here in all of this is to show you

198
00:25:02,000 --> 00:25:05,000
something else.

199
00:25:05,000 --> 00:25:18,000
Now remember that this is how we see, whenever you see a yield on a bond or an investment rate

200
00:25:18,000 --> 00:25:22,000
or anything like that, it's going to be one of these annualized.

201
00:25:22,000 --> 00:25:27,000
That way you can compare two investments, one that you've maybe held for a few days,

202
00:25:27,000 --> 00:25:32,000
one you've held for a few years, they're all in the same units,

203
00:25:32,000 --> 00:25:38,000
and you can compare them directly one against the other.

204
00:25:38,000 --> 00:25:51,000
So we go to the next situation, where I bring back that formula for interest rates.

205
00:25:51,000 --> 00:25:54,000
And I emphasize a few things again.

206
00:25:54,000 --> 00:26:02,000
The interest rate, any interest rate, has a substrate of R sub F.

207
00:26:02,000 --> 00:26:05,000
All interest rates will hold this piece.

208
00:26:05,000 --> 00:26:09,000
It is the same for all interest rates.

209
00:26:09,000 --> 00:26:20,000
It is underlying, so we know that it's there, and it isn't disappeared for one and reappeared for another.

210
00:26:20,000 --> 00:26:25,000
For example, let's try it this way.

211
00:26:25,000 --> 00:26:28,000
Sir, do you have a skeleton?

212
00:26:28,000 --> 00:26:30,000
You don't have a skeleton?

213
00:26:30,000 --> 00:26:32,000
Well, yeah, you've got one.

214
00:26:32,000 --> 00:26:35,000
I mean, you're not a jellyfish, you've got a skeleton.

215
00:26:35,000 --> 00:26:37,000
Madam, do you have a skeleton?

216
00:26:37,000 --> 00:26:40,000
Okay, it's smaller than his, but it's there.

217
00:26:40,000 --> 00:26:43,000
We know that you two have skeletons.

218
00:26:43,000 --> 00:26:45,000
That we can say, skeleton, skeleton.

219
00:26:45,000 --> 00:26:48,000
I got a CT scan last week.

220
00:26:48,000 --> 00:26:54,000
I mean, it's gross, the skull looking at it.

221
00:26:54,000 --> 00:26:58,000
Okay, but it's there, and it's always there.

222
00:26:58,000 --> 00:27:00,000
It's the same.

223
00:27:00,000 --> 00:27:11,000
Now, we keep in mind that inside of this is the real interest rate plus the expected inflation premium.

224
00:27:11,000 --> 00:27:18,000
Now, those two are the same for all interest rates, so it sets the rock solid bottom.

225
00:27:18,000 --> 00:27:41,000
Where the action happens is in that risk premium, that default premium plus the maturity premium plus the illiquidity premium.

226
00:27:41,000 --> 00:27:51,000
So if we're looking at the same instrument, same security, the same bond, what have you,

227
00:27:51,000 --> 00:27:55,000
as time goes along, it will have the same default premium.

228
00:27:55,000 --> 00:28:04,000
If I look at the two-year, five-year, it should have the same default premium and same illiquidity premium.

229
00:28:04,000 --> 00:28:15,000
Now, a yield curve.

230
00:28:15,000 --> 00:28:27,000
A yield curve takes the same bond, but looks at different maturities of it.

231
00:28:27,000 --> 00:28:34,000
A one-year, a two-year, a three-year, a five-year, a seven-year, ten-year, twenty-year, thirty-year.

232
00:28:34,000 --> 00:28:38,000
And on this, that's the horizontal axis.

233
00:28:38,000 --> 00:28:43,000
And then on the vertical axis is the yield.

234
00:28:43,000 --> 00:28:54,000
So what we should see, the R sub D and the R sub L should stay the same.

235
00:28:54,000 --> 00:28:56,000
R sub F will be the same.

236
00:28:56,000 --> 00:29:04,000
The only thing that is making a yield curve slope upward or downward is the maturity premium.

237
00:29:04,000 --> 00:29:10,000
Remember, the maturity premium gathers steam, gets bigger the farther out,

238
00:29:10,000 --> 00:29:16,000
because there's more chances of interest rates going up or down.

239
00:29:16,000 --> 00:29:25,000
Now, the one we use to do this analysis, first of all, well, the one we use to do this analysis is a treasury security.

240
00:29:25,000 --> 00:29:36,000
A very short-term, one-year, two-years, three-years, five-years, seven-ten, twenty-thirty.

241
00:29:36,000 --> 00:29:43,000
We look at the yield on treasury securities as time goes on.

242
00:29:43,000 --> 00:29:52,000
Now, one thing that we know is that treasury securities have virtually no default premium.

243
00:29:52,000 --> 00:30:01,000
And they have no illiquidity premium. You can sell a treasury, any kind of treasury bond, with a push of a button.

244
00:30:01,000 --> 00:30:04,000
So we know that those are going to stay the same.

245
00:30:04,000 --> 00:30:16,000
So what the yield curve on a treasury does is show the upward slope that is caused by the building maturity premium.

246
00:30:16,000 --> 00:30:22,000
Maturity premium on a twenty-year is higher than the maturity premium on a ten-year.

247
00:30:22,000 --> 00:30:28,000
The maturity premium on a ten-year is higher than the maturity premium on a seven-year,

248
00:30:28,000 --> 00:30:31,000
which is higher than the maturity premium on a five-year.

249
00:30:31,000 --> 00:30:40,000
So that is what a normal premium, a normal yield curve should look like.

250
00:30:40,000 --> 00:30:43,000
That's what it looks like. It's healthy.

251
00:30:43,000 --> 00:30:53,000
Now, we can have a situation where it swoops up way too much. It's too steep.

252
00:30:53,000 --> 00:31:04,000
Generally, that would be the result of markets saying that inflation is expected to be higher and higher as time goes on.

253
00:31:04,000 --> 00:31:07,000
But that's not very normal.

254
00:31:07,000 --> 00:31:11,000
Now, let me show you two abnormal yield curves.

255
00:31:11,000 --> 00:31:25,000
The first one we would never, ever want to see because it would be pretty much that's closing the shop on the economy.

256
00:31:25,000 --> 00:31:31,000
A yield curve that is exactly backwards. It's going down.

257
00:31:31,000 --> 00:31:37,000
We want to stay light years away from that.

258
00:31:37,000 --> 00:31:46,000
That's a depression, a massive depression yield curve that's going to last for years and years and years.

259
00:31:46,000 --> 00:31:52,000
And we want to stay away from that one as much as we can.

260
00:31:52,000 --> 00:31:58,000
Inflation, well, this one means that we've got deflation happening.

261
00:31:58,000 --> 00:32:00,000
Well, what's wrong with prices going down?

262
00:32:00,000 --> 00:32:09,000
Trust me, you don't want to see that because prices go down if you are nearing the end of an economy.

263
00:32:09,000 --> 00:32:12,000
Prices begin to start falling.

264
00:32:12,000 --> 00:32:21,000
That's a sign of an economy that's getting into the worst possible situation.

265
00:32:21,000 --> 00:32:25,000
So that one, we hope we don't ever see that one, ever, ever.

266
00:32:25,000 --> 00:32:29,000
But there's one that we do see from time to time.

267
00:32:29,000 --> 00:32:35,000
And it's very important because it's a forecaster of a recession that's coming.

268
00:32:35,000 --> 00:32:40,000
This one is called an inverted yield curve.

269
00:32:40,000 --> 00:32:50,000
It begins like a normal yield curve, but then a longer rate is lower than a shorter rate.

270
00:32:50,000 --> 00:32:55,000
That's a sign that we're going to have a recession.

271
00:32:55,000 --> 00:33:07,000
Every recession we've had was preceded about six to nine months before by an inverted yield curve.

272
00:33:07,000 --> 00:33:16,000
It's like a warning shot that here comes a recession.

273
00:33:16,000 --> 00:33:23,000
Now, there have been some yield curves that inverted, and it came out that it wasn't a recession.

274
00:33:23,000 --> 00:33:26,000
It's just like an economic pause.

275
00:33:26,000 --> 00:33:34,000
A recession is technically two quarters, two consecutive quarters of negative GDP growth.

276
00:33:34,000 --> 00:33:46,000
So sometimes, once in a while, an inverted yield curve will precede an economic pause instead of a full recession.

277
00:33:46,000 --> 00:33:54,000
But every full recession has been preceded by an inverted yield curve.

278
00:33:54,000 --> 00:34:02,000
So it's like, it's actually one of the most reliable predictors we have of what's coming in an economy.

279
00:34:02,000 --> 00:34:05,000
And you can do it. Anyone can do it.

280
00:34:05,000 --> 00:34:12,000
Now, let me show you something.

281
00:34:12,000 --> 00:34:22,000
Let me take us back to, now this is U.S. Department of Treasury's yield data on government debt instruments

282
00:34:22,000 --> 00:34:28,000
from three months on out to 30 years, I guess.

283
00:34:28,000 --> 00:34:38,000
And so we can look at, yeah, there were a couple that weren't there back then.

284
00:34:38,000 --> 00:34:44,000
Do you see how the yield curve is rising from the one year, two year?

285
00:34:44,000 --> 00:34:55,000
Usually we look at the one year to start with, but one year, two year, do you see how the yields are rising just nicely?

286
00:34:55,000 --> 00:34:59,000
That is a classic healthy yield curve.

287
00:34:59,000 --> 00:35:01,000
It looks good.

288
00:35:01,000 --> 00:35:07,000
And you can see that upward slope, that's these numbers, upward sloping.

289
00:35:07,000 --> 00:35:10,000
Always going up.

290
00:35:10,000 --> 00:35:26,000
But then, we get to the, let's go to the end of 2022.

291
00:35:26,000 --> 00:35:37,000
Look. Do you see how they were rising and then they start falling?

292
00:35:37,000 --> 00:35:45,000
Whoops, let me highlight those.

293
00:35:45,000 --> 00:35:49,000
Now that is an inversion from hell.

294
00:35:49,000 --> 00:36:00,000
Usually you'll see this, maybe the 10 year, well the 10 year below the 7 year, so you've got an inversion down and then it comes back up.

295
00:36:00,000 --> 00:36:05,000
Maybe a couple of them will be lower than the ones preceding.

296
00:36:05,000 --> 00:36:10,000
But this was the inverted yield curve from hell.

297
00:36:10,000 --> 00:36:17,000
It was unbelievably downward sloping for way out.

298
00:36:17,000 --> 00:36:30,000
That one was more like, a typical inversion would look like that.

299
00:36:30,000 --> 00:36:38,000
The inversion you're seeing was like that.

300
00:36:38,000 --> 00:36:43,000
In my lifetime I've never seen one like that.

301
00:36:43,000 --> 00:36:51,000
You're seeing something that hardly anyone knows, but it's historical.

302
00:36:51,000 --> 00:36:55,000
A curve like that at the end of 2022.

303
00:36:55,000 --> 00:37:06,000
Well of course, every economist and financial analyst worth his or her salt was saying, recession coming, horrible recession, OMG.

304
00:37:06,000 --> 00:37:08,000
Well you know what?

305
00:37:08,000 --> 00:37:16,000
It didn't happen. For the first time an inverted yield curve did not lead to a recession.

306
00:37:16,000 --> 00:37:25,000
It led to a slowdown, a very strong slowdown of the economy, but it didn't lead to a recession.

307
00:37:25,000 --> 00:37:31,000
So let's go to now.

308
00:37:31,000 --> 00:37:40,000
Let me go up here and let's look at 2024.

309
00:37:40,000 --> 00:37:42,000
No, yeah let's look.

310
00:37:42,000 --> 00:37:49,000
Obviously the data won't be a whole year's data, it'll just be the first couple of months.

311
00:37:49,000 --> 00:37:54,000
Okay, apply.

312
00:37:54,000 --> 00:37:58,000
Well look at that.

313
00:37:58,000 --> 00:38:02,000
The son of a dog is still inverted.

314
00:38:02,000 --> 00:38:04,000
Do you see it?

315
00:38:04,000 --> 00:38:09,000
It hasn't corrected the inversion yet.

316
00:38:09,000 --> 00:38:17,000
But we're now going from a recovery to what looks like an expansion.

317
00:38:17,000 --> 00:38:20,000
No recession on the horizon.

318
00:38:20,000 --> 00:38:30,000
And yet the yield curve, despite its historical accuracy or reliability I should say,

319
00:38:30,000 --> 00:38:34,000
is signaling something that didn't happen.

320
00:38:34,000 --> 00:38:38,000
We saw this in 2022, this inversion happened then.

321
00:38:38,000 --> 00:38:48,000
Should have had a serious recession from six to nine months after that, after the inversion started.

322
00:38:48,000 --> 00:38:50,000
Didn't happen, nothing really.

323
00:38:50,000 --> 00:38:58,000
And now we still have it inverted, screaming here comes a recession and there's no recession on the horizon.

324
00:38:58,000 --> 00:39:07,000
So you're living in financial economic times that are just kind of unprecedented.

325
00:39:07,000 --> 00:39:19,000
And we don't, well there is one possible explanation for why it's inverted but it's not a bad thing.

326
00:39:19,000 --> 00:39:30,000
You have to look over here at this.

327
00:39:30,000 --> 00:39:44,000
And you look, it is possible that what the markets are signaling is an expectation of dramatically falling expected inflation premium.

328
00:39:44,000 --> 00:39:48,000
That would be about the only explanation.

329
00:39:48,000 --> 00:39:52,000
It should that EIP should stay about the same.

330
00:39:52,000 --> 00:39:59,000
It might steepen the curve if there's expected inflation that's going to be bad down the road.

331
00:39:59,000 --> 00:40:14,000
But this seems to be saying that the reason it's inverted is that expected inflation premium is going to be draining out of the economy for the foreseeable future.

332
00:40:14,000 --> 00:40:27,000
That's about the only explanation that makes sense is the EIP is what's driving the inversion.

333
00:40:27,000 --> 00:40:30,000
So there you are though.

334
00:40:30,000 --> 00:40:35,000
Historically unique time and you're seeing it right there.

335
00:40:35,000 --> 00:40:44,000
We have an inverted yield curve but no evidence whatsoever of an impending recession in the next year.

336
00:40:44,000 --> 00:40:56,000
The data, the jobs data, manufacturing index, consumer confidence, all of those are pointing to recovery and or expansion of the economy.

337
00:40:56,000 --> 00:40:59,000
So that's that.

338
00:40:59,000 --> 00:41:06,000
Now let me show you, I'm going to keep this up here because I can't even use this stupid.

339
00:41:06,000 --> 00:41:10,000
There's something that they mention in the book, the forward rates.

340
00:41:10,000 --> 00:41:17,000
And forward rates, well I guess I actually could.

341
00:41:17,000 --> 00:41:18,000
Let me see.

342
00:41:18,000 --> 00:41:19,000
Let's see.

343
00:41:19,000 --> 00:41:21,000
I got to keep my eye.

344
00:41:21,000 --> 00:41:27,000
One two is right here.

345
00:41:27,000 --> 00:41:30,000
One two is right there.

346
00:41:30,000 --> 00:41:31,000
Well that's interesting.

347
00:41:31,000 --> 00:41:34,000
We'll talk about that in just a minute or two.

348
00:41:34,000 --> 00:41:52,000
But let me show you one of the uses of that formula right there for interest rates.

349
00:41:52,000 --> 00:41:57,000
Suppose that I have a triple A corporate bond.

350
00:41:57,000 --> 00:42:11,000
Right now the yield on that bond, this is a very safe bond.

351
00:42:11,000 --> 00:42:16,000
Very little chance that it's going to behave badly.

352
00:42:16,000 --> 00:42:26,000
So it's going to be the risk free rate, which is the same for all debt instruments for a given time.

353
00:42:26,000 --> 00:42:35,000
Plus the default premium for the triple A bond.

354
00:42:35,000 --> 00:42:42,000
Plus the maturity premium for the triple A bond.

355
00:42:42,000 --> 00:42:49,000
Plus the illiquidity premium for the triple A bond.

356
00:42:49,000 --> 00:42:56,000
Now suppose that this is a 10 year corporate triple A.

357
00:42:56,000 --> 00:42:58,000
It's got a maturity of 10 years.

358
00:42:58,000 --> 00:42:59,000
10 years out.

359
00:42:59,000 --> 00:43:03,000
So all these numbers are hinging on 10 years.

360
00:43:03,000 --> 00:43:06,000
R sub F will stay constant.

361
00:43:06,000 --> 00:43:15,000
Now let's look at a 10 year government bond.

362
00:43:15,000 --> 00:43:17,000
Technically it's a note.

363
00:43:17,000 --> 00:43:28,000
So that would be R sub F plus the default premium on a government bond.

364
00:43:28,000 --> 00:43:35,000
Plus the maturity premium on a government bond.

365
00:43:35,000 --> 00:43:46,000
Plus the illiquidity premium on a government bond.

366
00:43:46,000 --> 00:43:51,000
Now first things first, the illiquidity premium.

367
00:43:51,000 --> 00:43:58,000
There's going to be virtually none on either a corporate triple A or a government.

368
00:43:58,000 --> 00:44:02,000
You can push a button and sell them anytime you want.

369
00:44:02,000 --> 00:44:08,000
Liquidity is the efficiency with which an asset can be converted to another asset.

370
00:44:08,000 --> 00:44:09,000
Well there you go.

371
00:44:09,000 --> 00:44:13,000
Those corporate triple A bonds you can sell them instantly.

372
00:44:13,000 --> 00:44:15,000
Same with government bonds.

373
00:44:15,000 --> 00:44:20,000
So for these two bonds it's going to be a zero.

374
00:44:20,000 --> 00:44:24,000
Now the maturity premium.

375
00:44:24,000 --> 00:44:28,000
This bond is corporate 10 years.

376
00:44:28,000 --> 00:44:30,000
This is government 10 years.

377
00:44:30,000 --> 00:44:32,000
The 10 years is what matters.

378
00:44:32,000 --> 00:44:37,000
They will have identical maturity premiums because they're both 10 years.

379
00:44:37,000 --> 00:44:44,000
The volatility of interest rates in 10 years is going to be the volatility of interest rates for 10 years,

380
00:44:44,000 --> 00:44:48,000
so these two are going to match each other.

381
00:44:48,000 --> 00:44:58,000
The one that will be different is that the government bond will have no debt, no default premium.

382
00:44:58,000 --> 00:45:04,000
The corporate bond will have a default premium.

383
00:45:04,000 --> 00:45:08,000
Now let me subtract those two.

384
00:45:08,000 --> 00:45:14,000
Going from illiquidity premiums, zero minus zero will be a zero.

385
00:45:14,000 --> 00:45:26,000
If the maturity premiums are the same, then that will be zero when we subtract those.

386
00:45:26,000 --> 00:45:36,000
The R sub D of the triple A bond minus a zero on R sub D for the government bond

387
00:45:36,000 --> 00:45:45,000
means that this one will be R sub D, the default premium, on the corporate bond.

388
00:45:45,000 --> 00:45:49,000
The R sub S will be the same.

389
00:45:49,000 --> 00:45:55,000
So what this tells us is that if I take the yield on a corporate triple A bond

390
00:45:55,000 --> 00:46:02,000
and subtract the yield on the same maturity government bond,

391
00:46:02,000 --> 00:46:22,000
what I would find is the default premium on triple A bonds.

392
00:46:22,000 --> 00:46:24,000
We do this all the time to keep an eye on it.

393
00:46:24,000 --> 00:46:31,000
Like for example, suppose that the yield on the corporate bond is 4.68 percent

394
00:46:31,000 --> 00:46:41,000
and the yield on the government bond is 4.50 percent.

395
00:46:41,000 --> 00:46:51,000
Then if I subtract those two, I will get 0.18.

396
00:46:51,000 --> 00:47:02,000
That means that the default premium on high quality corporate debt is 18 basis points.

397
00:47:02,000 --> 00:47:04,000
Why does that matter?

398
00:47:04,000 --> 00:47:09,000
In and of itself probably doesn't tell us much, but we watch it over time.

399
00:47:09,000 --> 00:47:16,000
That default premium, if it gets bigger, then we know that the markets are assessing

400
00:47:16,000 --> 00:47:22,000
more risk of default by big corporations.

401
00:47:22,000 --> 00:47:28,000
If it gets smaller, then that risk of default is shrinking.

402
00:47:28,000 --> 00:47:37,000
That is a warning or a sign of the expectations of the economy.

403
00:47:37,000 --> 00:47:41,000
I can do the same thing with double A, single A,

404
00:47:41,000 --> 00:47:46,000
to see what different layers of corporate default are doing.

405
00:47:46,000 --> 00:47:50,000
Are they getting bigger? Are they getting smaller?

406
00:47:50,000 --> 00:47:56,000
Right now, they seem to be that R sub D seems to be contracting somewhat,

407
00:47:56,000 --> 00:48:03,000
which means the economy, the expectation is lower chance of default by big corporations.

408
00:48:03,000 --> 00:48:09,000
That's why we look at it, to see which way it's going or is it staying about the same.

409
00:48:09,000 --> 00:48:12,000
Now, I caution one quick thing about this.

410
00:48:12,000 --> 00:48:19,000
You can't really do this below single A bonds, triple A, double A, single A.

411
00:48:19,000 --> 00:48:28,000
The reason you can't do it below that is because you get down into lower grade corporate bonds, junk bonds,

412
00:48:28,000 --> 00:48:32,000
the illiquidity premium starts to show up.

413
00:48:32,000 --> 00:48:34,000
It's not immediate.

414
00:48:34,000 --> 00:48:39,000
I had a junk bond some years back and I put it in order to sell it.

415
00:48:39,000 --> 00:48:42,000
I just wanted to get out from under the day and gone thing.

416
00:48:42,000 --> 00:48:49,000
It took three days before there was an investor who would buy it.

417
00:48:49,000 --> 00:48:55,000
You can't really do this down there too low because the illiquidity premium starts to fuzz up.

418
00:48:55,000 --> 00:49:02,000
You get not just the R sub D, but you get a little bit of R sub I illiquidity in there as well.

419
00:49:02,000 --> 00:49:05,000
So there's that in there.

420
00:49:05,000 --> 00:49:11,000
Now the last thing to do in this, and I will not do this on a test,

421
00:49:11,000 --> 00:49:19,000
but you do see one question or they cover it a little bit in your homework.

422
00:49:19,000 --> 00:49:25,000
Let me get all this off the board here, not to scare you too much.

423
00:49:25,000 --> 00:49:35,000
But this right here.

424
00:49:35,000 --> 00:49:42,000
Well now I don't think I'm going to do that today.

425
00:49:42,000 --> 00:49:47,000
Let me just have you go ahead and, what time is it?

426
00:49:47,000 --> 00:49:55,000
Yeah, why don't you just go ahead and take the quiz and I'll cover the rest of it on Wednesday.

427
00:49:55,000 --> 00:50:23,000
But as far as material today is concerned, that's all I have for you. I thank you.