Chapter 9 - Interest rate forecasting and hedging: Swaps, financial futures, and options. This chapter is devoted to the forecasting (predicting) and hedging (risk protection activities) associated with changing interest rates and changes in the prices of financial assets. | Money and Capital Markets 9 C h a p t e r Eighth Edition Financial Institutions and Instruments in a Global Marketplace Peter S. Rose McGraw Hill / Irwin Slides by Yee-Tien (Ted) Fu Interest Rate Forecasting & Hedging: Swaps, Financial Futures, & Options Learning Objectives To see the effect of business cycle expansions and contractions upon interest rate movements. To consider the significance of seasonal movements in interest rates. To explore some interest-rate forecasting methods that are most widely used today. To examine several popular hedging tools, including interest rate swaps, financial futures, and option contracts. The Influence of the Business Cycle in Shaping Interest Rates and Asset Prices Interest rates tend to fall (and debt security prices rise) during a business recession, while interest rates typically rise (and debt security prices fall) during an economic expansion. These phases of the business cycle may last months or years. The Influence of the Business . | Money and Capital Markets 9 C h a p t e r Eighth Edition Financial Institutions and Instruments in a Global Marketplace Peter S. Rose McGraw Hill / Irwin Slides by Yee-Tien (Ted) Fu Interest Rate Forecasting & Hedging: Swaps, Financial Futures, & Options Learning Objectives To see the effect of business cycle expansions and contractions upon interest rate movements. To consider the significance of seasonal movements in interest rates. To explore some interest-rate forecasting methods that are most widely used today. To examine several popular hedging tools, including interest rate swaps, financial futures, and option contracts. The Influence of the Business Cycle in Shaping Interest Rates and Asset Prices Interest rates tend to fall (and debt security prices rise) during a business recession, while interest rates typically rise (and debt security prices fall) during an economic expansion. These phases of the business cycle may last months or years. The Influence of the Business Cycle in Shaping Interest Rates and Asset Prices Source: Federal Reserve Bank of St. Louis, National Economic Trends, May 2002 Recessions as defined by the National Bureau of Economic Research Relative Movements in Short- & Long-Term Rates & Prices over the Business Cycle In general, short-term interest rates tend to be more sensitive to business cycle changes than long-term interest rates on bonds and other capital market securities. On the other hand, long-term asset prices tend to be more volatile than the prices of short-term assets. Relative Movements in Short- & Long-Term Rates & Prices over the Business Cycle % Time Long- term interest rates Short- term interest rates Expansion Contraction Peak of boom Recession trough Recession trough Seasonality in Market Interest Rates There is evidence that interest rates also display seasonality, tending to be higher at some times of the year than at others. For example, short-term rates tend to rise through summer and autumn as businesses .
