Capital Markets

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Capital Markets
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Types of Capital

• Physical Capital
• trucks, computers, buildings
• Financial Capital
• bonds, corporate stocks
• Human Capital
• skills, education

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To derive demand for physical capital

• First, consider the case where capital is rented
• The firm must pay a rental rate for the capital

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Numerical Example
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To derive the demand curve for physical capital,
sketch a graph showing the marginal revenue
product of physical capital
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A Smooth Looking Demand for Physical Capital
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Equilibrium in the Market for Physical Capital
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For the case where firms own the capital

• There is an implicit rental price of capital
• implicit rental price equals interest plus
  depreciation
• example
• price of overhead projector 4000
• interest rate .10 (10 percent)
• depreciation 1000
• implicit rental rate (.10)(4000) 1000
  1400

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special case where supply is fixed
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Financial Capital

• debt promise to pay to pay interest and
  principal in the future
• examples corporate bonds, government bonds
• equity payment of dividends depends on firms
  profits
• example corporate stock
• stocks or bonds are traded on the stock market or
  the bond market--BIG QUESTION WHAT DETERMINES
  PRICE?

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Terminology of stocks

• return dividend plus capital gain
• rate of return return as a percent of price
• dividend yield
• earnings
• price-earnings ratio

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July 1, 1994 (Wall Street Journal)
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Terminology of bonds

• coupon
• maturity date
• face value
• yield
• market price

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Relationship between yield and price of a bond?

• F face value
• R Coupon
• P price
• i yield
• For a one year bond i (RF-P)/P
• Or, P (RF)/(1i)
• This is the present discounted value of next
  years F and R

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What determines the price of a bond?First,
lets auction off a bond and see what happens?
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