A mortgage involves making a promise, backing it with collateral, and defining a way to dissolve the promise at prearranged terms in case you want to end it by prepaying. The option to prepay, the refinancing option, makes the mortgage … Continued
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Callable Bonds and the Mortgage Prepayment Option
This lecture is about optimal exercise strategies for callable bonds, which are bonds bundled with an option that allows the borrower to pay back the loan early, if she chooses. Using backward induction, we calculate the borrower’s optimal strategy and … Continued
Backward Induction and Optimal Stopping Times
In the first part of the lecture we wrap up the previous discussion of implied default probabilities, showing how to calculate them quickly by using the same duality trick we used to compute forward interest rates, and showing how to … Continued
Uncertainty and the Rational Expectations Hypothesis
According to the rational expectations hypothesis, traders know the probabilities of future events, and value uncertain future payoffs by discounting their expected value at the riskless rate of interest. Under this hypothesis the best predictor of a firm’s valuation in … Continued
Will the Stock Market Decline when the Baby Boomers Retire?
In this lecture, we use the overlapping generations model from the previous class to see, mathematically, how demographic changes can influence interest rates and asset prices. We evaluate Tobin’s statement that a perpetually growing population could solve the Social Security … Continued
Overlapping Generations Models of the Economy
In order for Social Security to work, people have to believe there’s some possibility that the world will last forever, so that each old generation will have a young generation to support it. The overlapping generations model, invented by Allais … Continued
Economic Indicators – Unemployment Rate
This video talks about unemployment rate, which is one of the important economic indicators. The video discusses what unemployment rate is, it’s various characteristics, and how it affects financial markets.
Yield Curve Arbitrage
Where can you find the market rates of interest (or equivalently the zero coupon bond prices) for every maturity? This lecture shows how to infer them from the prices of Treasury bonds of every maturity, first using the method of … Continued
How a Long-Lived Institution Figures an Annual Budget Yield
In the 1990s, Yale discovered that it was faced with a deferred maintenance problem: the university hadn’t properly planned for important renovations in many buildings. A large, one-time expenditure would be needed. How should Yale have covered these expenses? This … Continued
Shakespeare’s Merchant of Venice and Collateral, Present Value and the Vocabulary of Finance
While economists didn’t have a good theory of interest until Irving Fisher came along, and didn’t understand the role of collateral until even later, Shakespeare understood many of these things hundreds of years earlier. The first half of this lecture … Continued
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