 So for this week, we're going to be looking at money and bond markets. We will understand a little bit about interest rates and how interest rates are determined. And then we will look at the yield curve and what kind of role yield curve plays in making a decision about investing in a particular bond. And then after this, we'll look at the difference between bond markets and money markets. Finally, we'll see what are the different types of bonds available out there. So to start things first, when we look at interest rates, the very first question that comes into mind is how are interest rates actually determined? Normally interest rates are determined by multiple factors. These could be based on the money supply and demand that's also based on the real GDP and on the general price levels. When we first look at money supply and money demand, basically when we talk about money supply, it refers to the amount of money or currency that is out there in circulation currently. Money demand on the other hand refers to the amount of money that is required or demanded from the households, from governments, from other institutions. So what amount of money or what amount of currency is in demand by these different parties? On the other hand, if we look at real GDP, now real GDP basically stands for the value of the final goods and services that were produced in a particular year and in a particular country. Now taking this real value or taking this final value, we adjust it to eliminate any particular effects of changes and price that might have occurred during that particular year. Now having seen what money supply, money demand and real GDP is, perhaps it is a little bit important to understand what is money market model, so for us to get a thorough understanding of how inflation plays a role and how inflation is a turning. So money market model is basically a model, an economic model that looks at the supply and demand of money in a particular country. And normally it involves two agents, so we have the, or two parties, we have the money holders and then we have the money issuers. Money holders, as you can imagine, are basically that the money demanded basically to facilitate particular transactions. Money issuers on the other hand are those who supply the money by creating currency. Now the money market model, what it does, it looks at the equilibrium in the money market and it looks at where the demand and money are equals to the supply of money. So basically it tries to make the supply and demand at an equal frame. Once the supply of money, once the money in circulation meets the money and demand, then here we reach the equilibrium point that the money market model looks for. Now the equilibrium interest rate here is basically, as we saw, is the quantity of money that is demanded and how it equals the quantity of the money that is supplied. And so once we have all of these in mind, once we have seen the money supply and money demand, the real GDP and we've seen the equilibrium and interest rate, now it is much easier for us to understand the determinants of interest rate. And so let's assume that we have a limited demand on money supply. So if money supply falls, then in this case the equilibrium of interest rate will increase. On the other hand, if the prices or if the price levels falls, equilibrium again in the equilibrium interest rate again will fall. Now what happens if real GDP falls? If real GDP falls, then the equilibrium interest rate will also fall. However, if interest rates are reduced, then the money demanded by those who need the money or by the governments or by the households is going to increase. On the other hand, if the interest rates are increasing, then the money demanded is going to decrease. So basically between money, between the money supplied and demand and between the interest rate, you will see that there is an opposite kind of relationship. If money, if interest rates are increasing, then the demand on money is going to decrease and vice versa. So now we're going to look at what the yield curve is. And the reason we want to look at the yield curve because it demonstrates the relationship between the cost of borrowing and the time to maturity. And as you remember from our first meeting together, time to maturity refers to the date when you are supposed to return back as an organization that has borrowed money, the date when you're supposed to be returning back the full amount of money that you've borrowed. And here what we want to see, we want to see what is the relationship that exists between the cost of borrowing and between that maturity date. Now the yield curve, what it does, it basically shows us the, how the interest rate looks across similar contract, across similar debt contracts, but that these debt contracts have perhaps different contract links to them. And so we will see the relationship again between the interest rate and between the maturity, the time to mature. And as part of the different results that we would get from the yield curve, we have some, we have three main results. The first one is a flat yield curve. Basically it's just flat. And this means that all the maturities, they have the same exact or similar yield. And this does not signal anything good for us. It perhaps is a sign of the times of uncertainty. Now on the other hand, if we have what is referred to as the hump yield is when we have the short term and long-term yields together equal, or equal, and then this, and on the other hand, you have the, the medium term yield higher than both short-term and long-term yields. So basically it looks something like that. And when we're looking at a hump yield, what it signals, it means that the yield on a particular bond or the yield on bonds increases first and then they decrease in relationship to the maturity and in relationship to the maturity. So if the maturity increases, then the bond increases and then it decreases. Now what also this demonstrates to us, it gives us somewhat of an alarming signal if we're talking about economies that are still transitioning economies. Now finally, the third kind of results that we could get from a yield curve is an inverted curve. And an inverted curve basically occurs when you have your long-term yield lower than the short term, lower than the short term yield. And in this case, the yields on the bonds are decreasing as the maturity keeps on increasing. Now, if we want to look at the bond markets and money markets, I try to understand a little bit more about how they are different from one another. Perhaps it is important for us to start thinking first about what money markets are. Now, as you remember, we said that money markets normally trade with short-term debt securities. And when we talk about short-term debt securities here, we're talking about securities that are traded for less than a year. So they have only less than a year to mature. So anything from few months up until 11, 12 months, these are the kind of securities that we're looking into. And normally money markets are looked into as cash investments because they're highly liquid and they are relatively safer if you want to compare them to bond markets because bond markets, again, have a little bit longer time frame for their securities to mature. Now, the yield for these kinds of, for money markets that they get on the return, so the kind of return that the yield are comparably lower than those that you can find in bond markets. And these are highly influenced by the amount of demand or the number of demand that is there on money and on currency. Now, money markets are basically used to generate short-term financing for a particular institution. And the transactions that occur within money markets are normally low transactions, but they have a high volume or high rate of transparency. On the other hand, if we're looking at bond markets, now bond markets are, again, debt securities just like money markets, but these debt securities have longer term to mature as compared money markets. And when we say longer term, basically from one to three years. Now, with that said, bond markets do not only trade with short-term securities, they also trade with long-term and with medium-term securities. So they could be even more than three years. Now, because of their nature, bond markets are a little riskier than money markets, and at the same time, they're not as liquid as money markets. But the returns that they generate, or the returns that money market, that bond markets yield, are higher if we are comparing them to money markets. And basically, bond markets are highly influenced by the expectations that investors have on inflation on the economic growth, perhaps their influence as well by the fiscal policies, by the credit quality. So they're influenced by a number of factors that would also have or play a huge role within bond markets. Now, bond markets, they are used as a way to raise long-term financing. So when we talk about long-term financing here, we're talking about financing for institutions that are looking to raise capital perhaps, but through debt financing. And so not like money markets, which are a way to raise short-term financing, perhaps to cover the expenses or expenditures. With that said, bond markets, unlike money markets, the transactions that occur are basically high number of transactions, but at the same time, they are low in terms of transparency. Now, to delve a little deeper into bonds and the different types or different categories of bonds, we have three main different categories of bonds. So we have domestic bonds, we have foreign bonds, and then we have the euro bonds. Now, the domestic bonds, and as you remember from the definition that we've looked into about bonds in the very first meeting that we had together, bonds are a debt financing method that are issued either by governments or by corporations. And these domestic bonds in particular are issued by a local government or by a corporation that operates within a particular geographic location using the currency of that particular country that they are operating within. Now, in general, as we move forward to look even at foreign bonds and that euro bonds, it is important for us to remember that when we want to differentiate between these three different categories of bonds, that we will be looking at three different key players or attributes that would help us identify whether a bond is domestic, foreign, or euro bond. These would be the issuing body. So who is the issuer? Where are they issuing the bond and which currency are they using? For domestic bonds, all of them are the same. So the issuing body is in a particular country and the currency that is used is basically the currency of that country. And then finally, the location of the issuing of these bonds are in the same country. So nothing changes. Everything is local here. For example, a bond that was issued by a government body could be the US Treasury bonds. And these Treasury bonds that were recently issued by the US within the US were basically to finance deficit and to manage the money supply. Now, a corporate bond, a corporate domestic bond could be that issued by Apple. And at that point, one of the newly issued bonds by Apple was basically issued to finance expenses, their expenditures, and part of it, the debt repayments. And these were issued in the US using the US dollar and for the use of the US market. Now, if we look at foreign bonds, remember the formula that we said the who is issuing and where are they issuing it and what currency they're using? Here, the mix is going to play a game. So when we're talking about foreign bonds, here we're talking about someone, an organization that is foreign. And by foreign, we mean it does not belong to the country where it intends to issue the bond in. And it is using basically the currency of the country where it wants to issue the bond within. So assuming we have Apple, and Apple wants to issue bonds in the UK, what they would do, they would go to the UK market, and then they would issue bonds using the pounds sterling for the use of the UK market. That would be regarded as a foreign bond. Now, there are many examples of foreign bonds. And these that we will be going through are just a few examples. For example, if we're talking Yankee bonds are dollar dominated bonds normally and they are issued by corporations that are not US corporations, but they are issued in the US using the US dollar. On the other hand, you have the bulldog bonds. And these are basically bonds that use the pounds sterling, and they are issued in the UK, but they are not issued by a UK organization. In our example about Apple, this is basically where it comes into play. Now, if we're talking about kangaroo bonds, these are bonds that are dominated by the Australian dollar. They are issued in Australia, but they are issued by a non-Australian company or organization. Now, if we want to make things a little bit more complicated, we'd look at Euro bonds. Now, remember the formula again, the who, where, and the currency? Here, everything is different. So the company does not necessarily belong to the country where it is used, where the currency that they used is from. And at the same time, they're not issuing the bonds in that particular country that they're using the currency from. So here, what we're talking about three different nationalities put it this way. So we're talking about a company from a particular country using the currency of a different country to be sold in a third country. An example of that would be the Euro dollar. Now, a Euro dollar is a dollar, US dollar dominated bond that is issued by an international company. And it's traded outside of the US and at the same time outside of the country of the issuing body. If we want to make an example would be perhaps a UK based company that is issuing a bond using a US dollar. And this bond is to be traded within the European market. Now, the Euro yen on the other hand is a Japanese yen denominated bond. It is issued again by an international entity. And this international entity from a particular country is using the yen. But the market that it's going to be selling these bonds are going to be a different and absolutely or completely different market. I know it sounds complicated, but it's very simple. Just remember the formula, the where, the currency and the who is the issuing body. Remember all of these and things will be very easy for you to understand the difference between foreign bonds and between Euro bonds because this is where most of the time things get a little complicated. Now with that, let's end with something interesting to think about. Now, what do you think about governments and corporations who are using debt financing as an option? Do you think that bonds are actually a good option for financing or do you think it is a hefty option and it's complicated? What are your thoughts? Good luck and I'll see you next week.