Investments, tenth edition

 Figure 1.1 

Short-term LIBOR and Treasury-bill rates and the TED spread          

Percent

Jan-00

Jul-00

Jan-01

Jul-01

Jan-02

Jul-02

Jan-03

Jul-03

Jan-04

Jul-04

Jan-05

Jul-05

Jan-06

Jul-06

Jan-07

Jul-07

Jan-08

Jul-08

Jan-09

Jul-09

Jan-10

Jul-10

Jan-11

Jul-11

Jan-12

Jul-12

0

1

2

3

4

5

6

7

8

3-month LIBOR

3-month T-Bill

TED spread

6

 LIBOR stands for London Interbank Offer Rate. It is a rate charged on dollar-denominated loans in an interbank 

lending market outside of the U.S. (largely centered in London). The rate is typically quoted for 3-month loans. 

The LIBOR rate is closely related to the Federal Funds rate in the U.S. The Fed Funds rate is the rate charged on 

loans between U.S. banks, usually on an overnight basis. 

7

 TED stands for Treasury–Eurodollar spread. The Eurodollar rate in this spread is in fact LIBOR. 

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  C H A P T E R  

1

  The Investment Environment

17

began rising noticeably in the late 1990s and accelerated dramatically after 2001 as inter-

est rates plummeted. In the 10 years beginning 1997, average prices in the U.S. approxi-

mately tripled.  

 But the newfound confidence in the power of macroeconomic policy to reduce risk, the 

impressive recovery of the economy from the high-tech implosion, and particularly the 

housing price boom following the aggressive reduction in interest rates may have sown 

the seeds for the debacle that played out in 2008. On the one hand, the Fed’s policy of 

reducing interest rates had resulted in low yields on a wide variety of investments, and 

investors were hungry for higher-yielding alternatives. On the other hand, low volatility 

and growing complacency about risk encouraged greater tolerance for risk in the search 

 Figure 1.2 

Cumulative returns on the S&P 500 index          

1980

1983

1986

1989

1992

1995

1998

2001

2004

2007

2010

2013

0

5

10

15

Cumulative Value of a $1 Investment

20

25

30

35

40

 Figure 1.3 

The Case-Shiller index of U.S. housing prices          

0

1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

50

100

150

200

Index (January 2000 = 100)

250

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18

P A R T   I

 Introduction

for these higher-yielding investments. Nowhere was this more evident than in the explod-

ing market for securitized mortgages. The U.S. housing and mortgage finance markets 

were at the center of a gathering storm.