Case Study: The Impact of the Federal Reserve Board’s Raising Interest Rates and Hurricane Rita on the U.S. Stock and Bond Markets: September 20 and 21, 2005 FNCE 3020 Financial Markets and Institutions Fall Semester 2005

Background Tuesday, September 20: –Federal Reserve Raises the fed funds rate 25 basis points to 3.75%. –Indicates more hikes to come. Wednesday, September 21 –Hurricane Rita upgraded to category 5 –Heading for Texas and U.S. offshore oil rigs. 25% of U.S. production is from this area! Questions: –What did these two events do to the stock market and bond markets. –Answer in terms of financial asset model developed in class.

The Fed and Rita: The Stock Market

Stock Market Explanation Stocks seen as having more risk. Why? –Higher interest rates. Pushing up cost of financing for companies. –Perhaps the Fed is over-reacting. Economic may turn down. –Impact of Rita on U.S. oil supplies and prices. Shift out of stocks in general –Oil stocks rally!

The Debt Markets: Sept 21, 2005

Bond Market Explanation In times of greater uncertainty, investors demand safety and liquidity. –Where so they get that? –Bond markets (i.e., U.S. Government Securities Markets). –Outward shift in the bond demand schedule Pushes up bond prices and drives down yields.

Outward Shift in the Demand for Bonds

And What About Gold? Sept 2005

Sources of Information Stock Index – Bonds (Rates) – –Gold Prices –