Financial Market Theory Tuesday, October 26, 2017 Professor Edwin T Burton

Federal Reserve Policy Until 2008 Tighten by selling treasuries (open market sales) – the idea is to raise interest rates Loosen by buying treasuries (open market purchases) – the idea is to lower interest rates Rates targeted: Overnight Repo Rate Federal Funds Rate Ability to influence longer rates is doubtful – e.g. “operation twist” in the 1960s After 2008 Quantitative easing ballooned the Fed balance sheet and ballooned Member Bank Reserves Makes it very difficult to get “excess reserves” low enough to influence lending rates Is basically a long term “easing” policy Effect was to have near zero rates for almost a decade October 26, 2017

The Corporate Bond Market Before Michael Milken (late 1970s) Limited to very few (less than 50), very high quality credits Weaker credits had to borrow from banks After Milken The High Yield (Junk Bond) Market Pioneered by Milken Exclusively operated by Milken until 1987 Now a huge market Greatly expanded the corporate bond market October 26, 2017

Other Considerations The Capital Stack The Debt Stack Vulture (distressed) investing Pricing: the yield curve, the “credit spread” October 26, 2017