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 Chapter 06 - Understanding Financial Markets and Institutions

CHAPTER 6 – UNDERSTANDING FINANCIAL MARKETS AND INSTITUTIONS

Questions

LG1 1. Classify the following transactions as taking place in the primary or secondary markets:
a. IBM issues $200 million of new common stock – primary market
b. The New Company issues $50 million of common stock in an IPO – primary market
c. IBM sells $5 million of GM preferred stock out of its marketable securities portfolio –
secondary market
d. The Magellan Fund buys $100 million of previously issued IBM bonds – secondary market
e. Prudential Insurance Co. sells $10 million of GM common stock – secondary market

LG2 2. Classify the following financial instruments as money market securities or capital market securities:
a. Federal funds – money market security
b. Common stock – capital market security
c. Corporate bonds – capital market security
d. Mortgages – capital market security
e. Negotiable certificates of deposit – money market security
f. U.S. Treasury bills – money market security
g. U.S. Treasury notes – capital market security
h. U.S. Treasury bonds – capital market security
i. State and government bonds – capital market security

LG3 3. What are the different types of financial institutions? Include a description of the main
services offered by each.

The different types of financial institutions are:

Commercial banks: depository institutions whose major assets are loans and whose major
liabilities are deposits. Commercial bank loans cover a broader range, including consumer,
commercial, and real estate loans, than do loans from other depository institutions. Because they
are larger and more likely to have access to public securities markets, commercial bank liabilities
generally include more nondeposit sources of funds, such as subordinate notes and debentures,
than do those of other depository institutions.

Thrifts: depository institutions including savings associations, savings banks, and credit unions.
Thrifts generally perform services similar to commercial banks, but they tend to concentrate their
loans in one segment, such as real estate loans or consumer loans. Credit unions operate on a not-
for-profit basis for particular groups of individuals, such as a labor union or a particular
company’s employees.

6-1
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 Chapter 06 - Understanding Financial Markets and Institutions

Insurance companies: protect individuals and corporations (policyholders) from financially

adverse events. Life insurance companies provide protection in the event of untimely death or
illness, and help in planning retirement. Property casualty insurance protects against personal
injury and liability due to accidents, theft, fire, and so on.

Securities firms and investment banks: underwrite securities and engage in related activities such
as securities brokerage, securities trading, and making markets in which securities trade.

Finance companies: make loans to both individuals and businesses. Unlike depository
institutions, finance companies do not accept deposits, but instead rely on short- and long-term
debt for funding, and many of their loans are collateralized with some kind of durable good, such
as washer/dryers, furniture, carpets and the like.

Mutual funds: pool many individuals’ and companies’ financial resources and invest those
resources in diversified asset portfolios.

Pension funds: offer savings plans through which fund participants accumulate savings during
their working years. Participants then withdraw their pension resources (which have presumably
earned additional returns in the interim) during their retirement years. Funds originally invested
in and accumulated in a pension fund are exempt from current taxation. Participants pay taxes on
distributions taken after age 55, when their tax brackets are (presumably) lower.

LG3 4. How would economic transactions between suppliers of funds (e.g., households) and users of
funds (e.g., corporations) occur in a world without FIs?

In such a world, suppliers of funds (e.g., households), generating excess savings by consuming
less than they earn, would have a basic choice. They could either hold cash as an asset or directly
transfer that cash by investing in the securities issued by users of funds (e.g., corporations,
governments, or retail borrowers). In general, demanders (users) of funds issue financial claims
(e.g., equity and debt securities) to finance the gap between their investment expenditures and
their internally generated funds, such as retained earnings or tax receipts. In a world without
financial institutions, we would have direct transfers of funds from fund suppliers to fund users.
In return, financial claims would flow directly from fund users to fund suppliers.

LG3 5. Why would a world limited to the direct transfer of funds from suppliers of funds to users of
funds likely result in quite low levels of fund flows?

In this economy without FIs, the amount of funds flowing between fund suppliers and
fund users through financial markets would likely to be quite low for several reasons. First, once
they have lent money in exchange for financial claims, fund suppliers would need to continually
monitor the use of their funds. Fund suppliers must ensure that fund users neither steal the funds
outright nor waste the funds on projects that have low or negative returns, since either theft or
waste would lower fund suppliers’ chances of being repaid and/or earning a positive return on
their investments (such as through the receipt of dividends or interest). Monitoring against theft,
misuse, or underuse of their funds would cost any given fund supplier a lot of time and effort,
and of course each fund supplier, regardless of the dollar value of the investment, would have to

6-2
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 Chapter 06 - Understanding Financial Markets and Institutions

carry out the same costly and time-consuming process. Further, many investors do not have the
financial training to understand the necessary business information to assess whether a securities
issuer is making the best use of their funds. In fact, so many investment opportunities are
available to fund suppliers, that even those trained in financial analysis rarely have the time to
monitor how their funds are used in all of their investments. The resulting lack of monitoring
increases the risk of directly investing in financial claims. Given these challenges, fund suppliers
would likely prefer to delegate the task of monitoring fund borrowers to ensure good
performance to others.

Second, many financial claims feature a long-term commitment (e.g., mortgages, corporate
stock, and bonds) for fund suppliers, thus creating another disincentive for fund suppliers to hold
direct financial claims that fund users may issue. Specifically, given the choice between holding
cash or holding long-term securities, fund suppliers may well choose to hold cash for its
liquidity, especially if they plan to use their savings to finance consumption expenditures before
their creditors expect to repay them. Fund suppliers may also fear that they will not find anyone
to purchase their financial claim and free up their funds. When financial markets are not very
developed, or deep, in terms of the number of active buyers and sellers in the market, such
liquidity concerns arise.

Finally, even though real-world financial markets provide some liquidity services by allowing
fund suppliers to trade financial securities among themselves, fund suppliers face price risk when
they buy securities—fund suppliers may not get their principal back, let alone any return on their
investment. Trading securities on secondary markets involves various transaction costs. The
price at which investors can sell a security on secondary markets such as the New York Stock
Exchange (NYSE) or NASDAQ may well differ from the price they initially paid for the
security. The investment community as a whole may change the security’s valuation between the
time the fund supplier bought it and when the fund supplier sold it. Further, dealers, acting as
intermediaries between buyers and sellers, charge transaction costs for completing a trade. So
even if an investor bought a security and then sold it the next day, the investor would likely lose
money from transaction and other costs.

LG3 6. How do FIs reduce monitoring costs associated with the flow of funds from fund suppliers to
fund users?

Financial institutions’ aggregation of funds from fund suppliers resolves a number of problems.
First, large FIs now have much greater incentive to collect information and monitor the ultimate
fund user’s actions, because the FI has far more at stake than any small individual fund supplier
would have.

Second, the FI performs the necessary monitoring function via its own internal experts,
alleviating the “free-rider” problem that arises when small fund suppliers leave it to each other to
collect information and monitor a fund user. In an economic sense, fund suppliers appoint the FI
as a delegated monitor to act on their behalf. For example, full-service securities firms, such as
Merrill Lynch, carry out investment research on new issues and make investment
recommendations for their retail clients (investors), while commercial banks collect deposits
from fund suppliers and lend these funds to ultimate users, such as corporations. An important

6-3
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 Chapter 06 - Understanding Financial Markets and Institutions

part of these FIs’ functions is their ability and incentive to monitor ultimate fund users.

LG3 7. How do FIs alleviate the problem of liquidity risk faced by investors wishing to invest in
securities of corporations?

Financial intermediaries provide additional liquidity to fund suppliers, acting as asset

transformers as follows: FIs purchase the financial claims that fund users issue―primary
securities such as mortgages, bonds, and stocks―and finance these purchases by selling financial
claims to household investors and other fund suppliers as deposits, insurance policies, or other
secondary securities. The secondary securities—packages or pools of primary claims—that FIs
collect and then issue are often more liquid than are the primary securities themselves.

LG4 8. What are six factors that determine the nominal interest rate on a security?

Specific factors that affect nominal interest rates for any particular security include: expected
inflation, the real interest rate, default risk, liquidity risk, special provisions regarding the use of
funds raised by a particular security issuer, and the security’s term to maturity.

LG4 9. What should happen to a security’s equilibrium interest rate as the security’s liquidity risk
increases?

The interest rate on a security reflects its relative liquidity, with highly liquid assets carrying the
lowest interest rates (all other characteristics remaining the same). Likewise, if a security is
illiquid, investors add a liquidity risk premium (LRP) to the interest rate on the security.

LG5 10. Discuss and compare the three explanations for the shape of the yield curve.

Explanations for the yield curve’s shape fall predominantly into three categories: the unbiased
expectations theory, the liquidity premium theory, and the market segmentation theory.

According to the unbiased expectations theory of the term structure of interest rates, at any given
point in time, the yield curve reflects the market's current expectations of future short-term rates.
The second popular explanation―the liquidity premium theory of the term structure of interest
rates—builds on the unbiased expectations theory. The liquidity premium idea is as follows:
Investors will hold long-term maturities only if these securities with longer term maturities are
offered at a premium to compensate for future uncertainty in the security’s value. The liquidity
premium theory states that long-term rates are equal to geometric averages of current and
expected short-term rates (like the unbiased expectations theory), plus liquidity risk premiums
that increase with the security’s maturity (this is the extension of the liquidity premium added to
the unbiased expectations theory). The market segmentation theory does not build on the
unbiased expectations theory or the liquidity premium hypothesis, but rather argues that
individual investors and FIs have specific maturity preferences, and convincing them to hold
securities with maturities other than their most preferred requires a higher interest rate (maturity
premium). The main thrust of the market segmentation theory is that investors do not consider
securities with different maturities as perfect substitutes. Rather, individual investors and FIs
have distinctly preferred investment horizons dictated by the dates when their liabilities will

6-4
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 Chapter 06 - Understanding Financial Markets and Institutions

come due.

LG5 11. Are the unbiased expectations and liquidity premium hypotheses explanations for the shape
of the yield curve completely independent theories? Explain why or why not.

No. The two hypotheses are related. Specifically, the liquidity premium hypothesis states that
long-term rates are equal to geometric averages of current and expected short-term rates (like the
unbiased expectations hypothesis), plus liquidity risk premiums that increase with the security’s
maturity (this is the extension of the liquidity premium added to the unbiased expectations
hypothesis).

LG6 12. What is a forward interest rate?

A forward rate is an expected or implied rate on a short-term security that will originate at some
point in the future.

LG6 13. If we observe a 1-year Treasury security rate that is higher than the 2-year Treasury security
rate, what can we infer about the 1-year rate expected one year from now?

A downward-sloping yield curve implies that the market expects future short-term interest rates
to fall.

Problems

Basic 6-1 Determinants of Interest Rates for Individual Securities A particular security’s default
Problems risk premium is 2 percent. For all securities, the inflation risk premium is 1.75 percent
LG4 and the real interest rate is 3.5 percent. The security’s liquidity risk premium is 0.25 percent and
maturity risk premium is 0.85 percent. The security has no special covenants. Calculate the
security’s equilibrium rate of return.

ij* = 1.75% + 3.50% + 2.00% + 0.25% + 0.85% = 8.35%

LG4 6-2 Determinants of Interest Rate for Individual Securities You are considering an
investment in 30-year bonds issued by Moore Corporation. The bonds have no special covenants.
The Wall Street Journal reports that 1-year T-bills are currently earning 1.25 percent. Your
broker has determined the following information about economic activity and Moore
Corporation bonds:

Real interest rate = 0.75%

Default risk premium = 1.15%
Liquidity risk premium = 0.50%
Maturity risk premium = 1.75%

a. What is the inflation premium?

Expected IP = i – RIR = 1.25% - 0.75% = 0.50%

6-5
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 Chapter 06 - Understanding Financial Markets and Institutions

b. What is the fair interest rate on Moore Corporation 30-year bonds?

ij* = 0.50% + 0.75% + 1.15% + 0.50% + 1.75% = 4.65%

LG4 6-3 Determinants of Interest Rates for Individual Securities Dakota Corporation 15-year
bonds have an equilibrium rate of return of 8 percent. For all securities, the inflation risk
premium is 1.75 percent and the real interest rate is 3.50 percent. The security’s liquidity risk
premium is 0.25 percent and maturity risk premium is 0.85 percent. The security has no special
covenants. Calculate the bond’s default risk premium.

8.00% = 1.75% + 3.50% + DRP + 0.25% + 0.85%

=> DRP = 8.00% - (1.75% + 3.50% + 0.25% + 0.85%) = 1.65%

LG4 6-4 Determinants of Interest Rates for Individual Securities A 2-year Treasury security
currently earns 1.94 percent. Over the next two years, the real interest rate is expected to be 1.00
percent per year and the inflation premium is expected to be 0.50 percent per year. Calculate the
maturity risk premium on the 2-year Treasury security.

1.94% = 0.50% + 1.00% + 0.00% + 0.00% + MP

=> MP = 1.94% - (0.50% + 1.00% + 0.00% + 0.00%) = 0.44%

LG5 6-5 Unbiased Expectations Theory Suppose that the current 1-year rate (1-year spot rate) and
expected 1-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively)
are as follows:

1R1 = 6%, E(2r1) = 7%, E(3r1) = 7.5% E(4r1) = 7.85%

Using the unbiased expectations theory, calculate the current (long-term) rates for 1-, 2-, 3-, and
4-year-maturity Treasury securities. Plot the resulting yield curve.

1R1= 6%
1/2
1R2 = [(1 + 0.06)(1 + 0.07)] - 1 = 6.50%
1/3
1R3 = [(1 + 0.06)(1 + 0.07)(1 + 0.075)] - 1 = 6.83%
1/4
1R4 = [(1 + 0.06)(1 + 0.07)(1 + 0.075)(1 + 0.0785)] - 1 = 7.09%

6-6
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 Chapter 06 - Understanding Financial Markets and Institutions

Yield to
Maturity

7.09%

6.83%

6.50%

6.00%
_____________________________ Term to Maturity
0 1 2 3 4 (in years)

LG5 6-6 Unbiased Expectations Theory One-year Treasury bills currently earn 1.45 percent. You
expected that one year from now, 1-year Treasury bill rates will increase to 1.65 percent. If the
unbiased expectations theory is correct, what should the current rate be on 2-year Treasury
securities?

1R2 = [(1 + 0.0145)(1 + 0.0165)]1/2 - 1 = 1.55%

LG5 6-7 Liquidity Premium Hypothesis One-year Treasury bills currently earn 3.45 percent. You
expected that one year from now, 1-year Treasury bill rates will increase to 3.65 percent. The
liquidity premium on 2-year securities is 0.05 percent. If the liquidity theory is correct, what
should the current rate be on 2-year Treasury securities?

1R2 = [(1 + 0.0345)(1 + 0.0365 + 0.0005)]1/2 - 1 = 3.58%

LG5 6-8 Liquidity Premium Hypothesis Based on economists’ forecasts and analysis, 1-year
Treasury bill rates and liquidity premiums for the next four years are expected to be as follows:

R1 = 0.65%

E(2r1) = 1.75% L2 = 0.05%

E(3r1) = 1.85% L3 = 0.10%

E(4r1) = 2.15% L4 = 0.12%

Using the liquidity premium hypothesis, plot the current yield curve. Make sure you label the
axes on the graph and identify the four annual rates on the curve both on the axes and on the
yield curve itself.

1R1 = 0.65%
1/2
1R2 = [(1 + 0.0065)(1 + 0.0175 + 0.0005)] - 1 = 1.22%

6-7
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 Chapter 06 - Understanding Financial Markets and Institutions

1R3 = [(1 + 0.0065)(1 + 0.0175 + 0.0005)(1 + 0.0185 + 0.0010)]1/3 - 1 = 1.47%

1/4
1R4 = [(1 + 0.0065)(1 + 0.0175 + 0.0005)(1 + 0.0185 + 0.0010)(1 + 0.0215 + 0.0012)] -1=
1.67%

Yield to
Maturity

1.67%

1.47%

1.22%

0.65%
_____________________________ Term to Maturity
0 1 2 3 4 (in years)

Intermediate 6-9 Determinants of Interest Rates for Individual Securities Tom and Sue’s Flowers,
Problems Inc.’s, 15-year bonds are currently yielding a return of 8.25 percent. The expected
LG4 inflation premium is 2.25 percent annually and the real interest rate is expected to be 3.50
percent annually over the next 15 years. The default risk premium on Tome and Sue’s Flowers’
bonds is 0.80 percent. The maturity risk premium is 0.75 percent on five-year securities and
increases by 0.04 percent for each additional year to maturity. Calculate the liquidity risk
premium on Tom and Sue’s Flowers, Inc.’s, 15-year bonds. (LG4)

8.25% = 2.25% + 3.50% + 0.80 + LRP + (0.75% + (0.04% x 10))

=> LRP = 8.25% - (2.25% + 3.50% + 0.80% + (0.75% + (0.04% x 10))) = 0.55%

LG4 6-10 Determinants of Interest Rates for Individual Securities Nikki G’s Corporation’s 10-
year bonds are currently yielding a return of 6.05 percent. The expected inflation premium is
1.00 percent annually and the real interest rate is expected to be 2.10 percent annually over the
next ten years. The liquidity risk premium on Nikki G’s bonds is 0.25 percent. The maturity risk
premium is 0.10 percent on 2-year securities and increases by 0.05 percent for each additional
year to maturity. Calculate the default risk premium on Nikki G’s 10-year bonds.

6.05% = 1.00% + 2.10% + DRP + 0.25% + (0.10% + (0.05% × 8))

=> DRP = 6.05% - (1.00% + 2.10% + 0.25% + (0.10% + (0.05% x 8))) = 2.20%

6-8
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 Chapter 06 - Understanding Financial Markets and Institutions

LG4 6-11 Unbiased Expectations Theory Suppose we observe the following rates: 1R1 = 8%, 1R2 =
10%. If the unbiased expectations theory of the term structure of interest rates holds, what is the
1-year interest rate expected one year from now, E(2r1)?

1 + 1R2 = {(1 + 1R1)(1 + E(2r1))}1/2

1.10 = {1.08(1 + E(2r1))}1/2
1.21= 1.08 (1 + E(2r1))
1.21/1.08 = 1 + E(2r1)
1 + E(2r1) = 1.12
E(2r1) = 12%

LG5 6-12 Unbiased Expectations Theory The Wall Street Journal reports that the rate on 4-year
Treasury securities is 1.60 percent and the rate on 5-year Treasury securities is 2.15 percent.
According to the unbiased expectations hypotheses, what does the market expect the 1-year
Treasury rate to be four years from today, E(5r1)?

1 + 1R5 = {(1 + 1R4)4(1 + E(5r1))}1/5

1.0215 = {(1.016)4(1 + E(5r1))}1/5
(1.0215)5 = (1.016)4 (1 + E(5r1))
(1.0215)5 / (1.016)4 = 1 + E(5r1)
1 + E(5r1) = 1.0438
E(5r1) = 4.38%

LG5 6-13 Liquidity Premium Hypothesis The Wall Street Journal reports that the rate on 3-year
Treasury securities is 5.25 percent and the rate on 4-year Treasury securities is 5.50 percent. The
1-year interest rate expected in three years is, E(4r1), 6.10 percent. According to the liquidity
premium hypotheses, what is the liquidity premium on the 4-year Treasury security, L4?

1 + 1R4 = {(1 + 1R3)3(1 + E(4r1) + L4)}1/4

1.0550 = {(1.0525)3(1 + 0.0610 + L4)}1/4
(1.0550)4 = (1.0525)3(1 + 0.0610 + L4)
(1.0550)4 / (1.0525)3 = 1 + 0.0610 + L4
(1.0550)4 / (1.0525)3 – 1.0610 = L4 = 0.15%

LG5 6-14 Liquidity Premium Hypothesis Suppose we observe the following rates: 1R1 = 0.75%, 1R2
= 1.20%, and E(2r1) = 0.907%. If the liquidity premium theory of the term structure of interest
rates holds, what is the liquidity premium for year 2, L2?

1 + 1R2 = {(1 + 1R1)(1 + E(2r1) + L2)}1/2

1.012 = {(1.0075)(1 + 0.00907 + L2)}1/2
(1.012)2 = (1.0075)(1 + 0.00907 + L2)
(1.012)2/(1.0075) = 1 + 0.00907 + L2
(1.012)2/(1.0075) – 1.00907 = L2 = 0.745%

6-9
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 Chapter 06 - Understanding Financial Markets and Institutions

LG6 6-15 Forecasting Interest Rates You note the following yield curve in The Wall Street Journal.
According to the unbiased expectations hypothesis, what is the 1-year forward rate for the period
beginning one year from today, 2f1?

Maturity Yield
One day 2.00%
One year 5.50
Two years 6.50
Three years 9.00

= 0.065 = [(1 + .055)(1 + 2f1)]1/2 - 1

1R2
=> [(1.065)2 / (1.055)] - 1 = 2f1 = 7.51%

LG6 6-16 Forecasting Interest Rates On March 11, 20XX, the existing or current (spot) 1-, 2-, 3-,
and 4-year zero-coupon Treasury security rates were as follows:

1R1 = 0.75%, 1R2 = 1.35%, 1 R3 = 1.75%, 1R4 = 1.90%

Using the unbiased expectations theory, calculate the 1-year forward rates on zerocoupon
Treasury bonds for years 2, 3, and 4 as of March 11, 20XX.

2f1 = [(1 + 1R2)2/(1 + 1R1)] - 1 = [(1 + 0.0135)2/(1 + 0.0075)] - 1 = 1.95%

3 2 3 2
3f1 = [(1 + 1R3) /(1 + 1R2) ] - 1 = [(1 + 0.0175) /(1 + 0.0135) ] - 1 = 2.56%
4 3 4 3
4f1 = [(1 + 1R4) /(1 + 1R3) ] - 1 = [(1 + 0.0190) /(1 + 0.0175) ] - 1 = 2.35%

Advanced 6-17 Determinants of Interest Rates for Individual Securities The Wall Street Journal reports
problems that the current rate on 10-year Treasury bonds is 7.25 percent, on 20-year Treasury
LG4 bonds is 7.85 percent, and on a 20-year corporate bond issued by MHM Corp. is 8.75 percent.
Assume that the maturity risk premium is zero. If the default risk premium and liquidity risk
premium on a 10-year corporate bond issued by MHM Corp. is the same as those on the 20-year
corporate bond, calculate the current rate on MHM Corp.’s 10-year corporate bond.

20-year corporate bond: 8.75% = 7.85% + DRP + LRP + 0.00% => DRP + LRP = 8.75% -
7.85% = 0.90%
10-year corporate bond: ij* = 7.25% + 0.90% = 8.15%

LG4 6-18 Determinants of Interest Rates for Individual Securities The Wall Street Journal reports
that the current rate on 5-year Treasury bonds is 1.85 percent and on 10-year Treasury bonds is
3.35 percent. Assume that the maturity risk premium is zero. Calculate the expected rate on a 5-
year Treasury bond purchased five years from today, E(5r5).

1 + 1R10 = {(1 + 1R5)5(1 + E(5r5))5}1/10 = 1.0335 = {(1 + 0.0185)5(1 + E(5r5))5}1/10

=> E(5r5) = {(1.0335)10 / (1 + 0.0185)5}1/5 – 1 = 4.87%

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LG5 6-19 Unbiased Expectations Theory Suppose we observe the 3-year Treasury security rate
(1R3) to be 8 percent, the expected 1-year rate next year,(E(2r1),to be 4 percent, and the expected
1-year rate the following year, E(3r1),to be 6 percent. If the unbiased expectations theory of the
term structure of interest rates holds, what is the 1-year Treasury security rate, 1R1?

1.08 = {(1 + 1R1)(1 + E(2r1))(1 + E(3r1))}1/3

1.08 = {(1 + 1R1) × 1.04 × 1.06}1/3
(1.08)3 = (1 + 1R1 ) × 1.04 × 1.06
1 + 1R1 = 1.2597 / (1.04 × 1.06)
1R1 = 14.27%

LG5 6-20 Unbiased Expectations Theory The Wall Street Journal reports that the rate on 3-year
Treasury securities is 1.20 percent and the rate on 5-year Treasury securities is 2.15 percent.
According to the unbiased expectations hypotheses, what does the market expect the 2-year
Treasury rate to be three years from today, E(3r2)?

1 + 1R5 = {(1 + 1R3)3(1 + E(3r2))2}1/5 = 1.0215 = {(1 + 0.0120)3(1 + E(3r2))2}1/5

=> E(3r2) = {(1.0215)5 / (1 + 0.0120)3}1/2 – 1 = 3.59%

LG6 6-21 Forecasting Interest Rates Assume the current interest rate on a 1-year Treasury bond
(1R1) is 4.50 percent, the current rate on a 2-year Treasury bond (1R2) is 5.25 percent, and the
current rate on a 3-year Treasury bond (1R3) is 6.50 percent. If the unbiased expectations theory
of the term structure of interest rates is correct, what is the 1-year forward rate expected on
Treasury bills during year 3, 3f1?

1R1 = 4.50%
1R2 = 5.25% = [(1 + .045)(1 + 2f1)]1/2 - 1 => 2f1 = 6.01%
1/3
1R3 = 6.50% = [(1 + .045)(1 + .0601)(1 + 3f1)] - 1 => 3f1 = 9.04%

LG6 6-22 Forecasting Interest Rates A recent edition of The Wall Street Journal reported interest
rates of 1.25 percent, 1.60 percent, 1.98 percent, and 2.25 percent for three-year, four-year, five-
year, and six-year Treasury security yields, respectively, According to the unbiased expectation
theory of the term structure of interest rates, what are the expected one-year forward rates for
years 4, 5, and 6?

1 + 1R4 = {(1 + 1R3)(1 + 4f1)}1/4

1.016 = {(1.0125)3(1 + 4f1)}1/4
(1.016)4 = (1.0125)3(1 + 4f1))
(1.016)4 / (1.0125)3 = 1 + 4f1
1 + 4f1 = 1.02657
4f1 = 2.66%

6-11
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Chapter 06 - Understanding Financial Markets and Institutions

1 + 1R5 = {(1 + 1R4)4(1 + 5f1)}1/5

1.0198 = {(1.016)4(1 + 5f1)}1/5
(1.0198)5 = (1.016)4(1 + 5f1)
(1.0198)5/(1.016)4 = 1+5f1
1 + 5f1 = 1.03514
5f1 = 3.51%

1 + 1R6 = {(1 + 1R5)5(1 + 6f1)}1/6

1.0225 = {(1.0198)5(1 + 6f1)}1/6
(1.0225)6 = (1.0198)5(1 + 6f1)
(1.0225)6/(1.0198)5 = 1 + 6f1
1 + 6f1 = 1.03611
6f1 = 3.611%

6-12
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Chapter 06 - Understanding Financial Markets and Institutions

Research It!
Spreads
Go to the Federal Reserve Board’s Web site at www.federalreserve.gov and get the latest rates
on 10-year T-bills and Aaa- and Baa-rated corporate bonds using the following steps.

Go to the Federal Reserve’s Web site at www.federalreserve.gov . Click on “Economic

Research and Data,” then click on “Statistical: Releases and Historical Data.” Go to “Selected
Interest Rates: Weekly.” This will bring the file onto your computer that contains the relevant
data. Calculate the current spread of Aaa- and Baa-rated bonds over the 10-year Treasury-bond
rate. How have these spreads changed over the last two years?

SOLUTION: The solution will vary with the year the annual report is accessed. However, these
spreads help investors determine how much they must charge issuers other than the U.S.
government as a premium for any perceived probability of default. The difference between a
quoted interest rate on a security and a Treasury security with similar maturity, liquidity, tax, and
other features is called a default or credit risk premium.

Integrated Mini Case: Calculating Interest Rates

From discussions with your broker, you have determined that the expected inflation premium is
1.35 percent next year, 1.50 percent in year 2, 1.75 percent in year 3, and 2.00 percent in year 4
and beyond. Further, you expect that real interest rates will be 3.20 percent next year, 3.30
percent in year 2, 3.75 percent in year 3, and 3.80 percent in year 4 and beyond. You are
considering an investment in either 5-year Treasury securities or 5-year bonds issued by PeeWee
Corporation. The bonds have no special covenants. Your broker has determined the following
information about economic activity and PeeWee Corporation 5-year bonds:

Default risk premium = 2.10%

Liquidity risk premium = 1.75%
Maturity risk premium = 0.75%

Further, the maturity risk premium on PeeWee bonds is 0.1875 percent per year starting in year
2. PeeWee’s default risk premium and liquidity risk premium do not change with bond maturity.

a. What is the fair interest rate on 5-year Treasury securities?

6-13
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 Chapter 06 - Understanding Financial Markets and Institutions

b. What is the fair interest rate on PeeWee Corporation 5-year bonds?

c. Plot the 5-year yield curve for the Treasury securities.
d. Plot the 5-year yield curve for the PeeWee Corporation bonds.

SOLUTION:
a. What is the fair interest rate on 5-year Treasury securities?

1R5 = [(1 + 0.0135 + 0.032)(1 + 0.015 + 0.033)(1 + 0.0175 + 0.0375)(1 + 0.02 + 0.038) (1 + 0.02 +
0.038)]1/5 - 1 = 5.2887%

b. What is the fair interest rate on PeeWee Corporation 5-year bonds?

Rate on 5-year PeeWee bonds = 5.2887% + 2.10% + 1.75% + 0.75% = 9.89%

c. Plot the 5-year yield curve for the Treasury securities.

1R1 = 1.35% + 3.20% = 4.55%

1R2 = [[(1 + 0.0455)(1 + 0.015 + 0.033)]1/2 – 1] = 4.67%
1R3 = [[(1 + 0.0455)(1 + 0.015 + 0.033)(1 + 0.0175 + 0.0375)]
1/3
– 1] = 4.95%
1R4 = [[(1 + 0.0455)(1 + 0.015 + 0.033)(1 + 0.0175 + 0.0375)(1 + 0.02 + 0.038)]
1/4
– 1] = 5.16%
R
1 5 = [[(1 + 0.0455)(1 + 0.015 + 0.033)(1 + 0.0175 + 0.0375)(1 + 0.02 + 0.038) (1 + 0.02 +
0.038)] – 1] = 5.29%
1/5

Yield to Maturity
5.29%

5.16%

4.95%

4.67%

4.55%
___________________________________ Term to Maturity
0 1 2 3 4 5 (in years)

d. Plot the 5-year yield curve for the PeeWee Corporation bonds.

1R1 = 1.35% + 3.20% + 2.10% + 1.75% = 8.40%

1R2 = [[(1 + 0.0455)(1 + 0.015 + 0.033)]1/2 – 1] + 0.0210 + 0.0175 + 0.001875 = 8.71%
1R3 = [[(1 + 0.0455)(1 + 0.048)(1 + 0.0175 + 0.0375)]
1/3
– 1] + 0.0210 + 0.0175 + 0.00375= 9.17%

6-14
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 Chapter 06 - Understanding Financial Markets and Institutions

1R4 = [[(1 + 0.0455)(1 + 0.048)(1 + 0.055)(1 + 0.02 + 0.038)]1/4 – 1] + 0.0210 + 0.0175 + 0.005625 = 9.57%
1R5 = [[(1 + 0.0455)(1 + 0.048)(1 + 0.055)(1 + 0.058) (1 + 0.02 + 0.038)]
1/5
– 1] + 0.0210 + 0.0175 + .0075 =
9.89%

Yield to Maturity
9.89%

9.57%

9.17%

8.71%

8.40%
___________________________________ Term to Maturity
0 1 2 3 4 5 (in years)

6-15
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THE HORSE IN AMERICA

Original lithograph published by Currier &

Ives.

FLORA TEMPLE

This remarkable mare was the first

trotter to go a mile better than 2.20. For
more than six years she was called
“Queen of the Trotting Turf.” Nothing is
known as to her breeding, but from 1853
to 1859 she beat all the good horses in
the country. She was a light bay, 14⅛
hands in height, and weighed 835
pounds when in training.
 The Horse
IN AMERICA
A PRACTICAL TREATISE ON THE
VARIOUS TYPES COMMON IN THE
UNITED STATES, WITH SOMETHING
OF THEIR HISTORY AND VARYING
CHARACTERISTICS

BY
JOHN GILMER SPEED

Illustrated

NEW YORK
McCLURE, PHILLIPS & CO.
MCMV
 Copyright, 1905, by
McCLURE, PHILLIPS & CO.
Published, October, 1905

THIS BOOK
THE AUTHOR DEDICATES TO HIS FRIEND
COLONEL CLARENCE R. EDWARDS, U.S.A.
WHOSE INHERITED LOVE FOR HORSES HAS
BEEN CULTIVATED BY STUDY AND
STRENGTHENED BY PRACTICE
 CONTENTS

INTRODUCTION
CHAPTER ONE PREHISTORIC AND EARLY HORSES
CHAPTER TWO ARAB AND BARB HORSES
CHAPTER THREE THE THOROUGHBRED IN AMERICA
CHAPTER FOUR THE MORGAN HORSE
CHAPTER FIVE MESSENGER AND THE EARLY TROTTERS
CHAPTER SIX RYSDYK’S HAMBLETONIAN AND THE STANDARD
BRED TROTTERS
CHAPTER SEVEN THE CLAY AND CLAY-ARABIAN
CHAPTER EIGHT THE DENMARK, OR KENTUCKY SADDLE-HORSE
CHAPTER NINE THE GOVERNMENT AS A BREEDER
CHAPTER TEN FOREIGN HORSES OF VARIOUS KINDS
CHAPTER ELEVEN THE BREEDING OF MULES
CHAPTER TWELVE HOW TO BUY A HORSE
CHAPTER THIRTEEN THE STABLE AND ITS MANAGEMENT
CHAPTER FOURTEEN RIDING AND DRIVING
CHAPTER FIFTEEN TRAINING VS. BREAKING
CHAPTER SIXTEEN CONFORMATION AND ACTION
INDEX
 INTRODUCTION

There have been so many books written about horses that in

offering a new one I feel that an explanation, if not an apology, is
due. And I am embarrassed as to how to frame the explanation
without seeming to reflect on the books previously given to the
public. Nothing could be further from my desire. Most of these
previous books have been devoted to special kinds or types of
horses without any effort to cover a very broad field. Some others
have been frankly partizan with the avowed purpose of proving that
this type or that was the only one that was worth serious
consideration. All these are interesting, but valuable chiefly to the
careful student bent on going into the subject of horse breeding and
horse training in all of its branches. To do this an ordinary reader
would have to study half a hundred books with the danger of
becoming confused in the multiplicity of theories and conflicting
statements and with the final result of knowing as little in the end as
in the beginning. In this modest little volume I have endeavored
briefly to show how the horses in America have been developed and
have come to be what they are to-day. If I have succeeded even
partly in my purpose I will have my ample reward; if I fail, my book
will end on a few dusty library shelves along with hundreds of others
on kindred subjects.
There is a peculiar characteristic of most writers on the horse. Let a
man be ever so fair in his ordinary business and social life, he is apt,
when he becomes interested in horses, to throw away his judicial
attitude and change into an advocate who sees only one side. When
his interest in that one side carries him to the length of writing, the
tendency is to be so partizan that he is even discourteous to others
who do not agree with him. This queer disposition to wrangle and
dispute is due, no doubt, to the fact that horse breeding is not yet
by any means an exact science, and the data, guiding even those
who exercise the greatest care and intelligence, is not trustworthy.
We do not know with certainty how any of the great types has been
produced, for the beginnings of all of them are covered up by
fictions, based on traditions not recorded, but handed down from
generation to generation, or on fictions that have been
manufactured with ingenious mendacity. All this is a pity, but there is
no help for it now. What we can do is to tell what is true, show what
has been demonstrated by known achievements and go on working
in the material that we have at hand, so that we may assist in
increasing the great property value that this country has in its
horses.
That property value is immense. In the beginning of 1905, the
Agricultural Department estimated that the (taxable) value of the
horses in the United States was $1,200,310,020, and of mules
$251,840,378, or a total of $1,452,150,398. This is only about eight
per cent less than the aggregate value of the cows, beef cattle,
sheep and hogs in the whole country. Merely, therefore, from an
economic standpoint this question of preserving and increasing the
value of horses is one of prime importance. At this particular time it
is a question not only of increasing, but even of preserving, this
value, for new agencies are coming into competition with horses for
many purposes and are being substituted for horses in many others.
The automobiles and the electric tramways are not merely passing
fads. They have come to stay until substituted by something else
which has not yet swum into our ken. The common horses will soon
be obsolete except on our farms, and even on the farms they ought
to be given up, for, notwithstanding all the great breeding
establishments in the various states, by far the greater number of
the horses are bred on the farms at present. That should always be
the case; but it may not be so when the time comes that is rapidly
approaching and a common horse will have next to no value at all.
Farmers more than others need to realize that only such horses
should be bred that will have a value for other than strictly farm
work, for a farmer should be able to sell his surplus stock with a fair
profit. If farmers have not the foresight to anticipate the inevitable,
then they will have to accept the loss that will surely ensue.
Every breeder whether farmer, amateur or professional, should
breed to a type. Any other method is merely a haphazard waste of
time and money. When I say breed to a type, I mean always a
reproducing type. There are several such in this country, a few of
which belong to us, though most of them are of foreign origin. The
Thoroughbred is English, the Percheron is French, the Hackney is
English, the Orlof is Russian, the Clydesdale is English, the Morgan is
American, the Denmark is American, the Clay-Arabian is American,
and the standard bred trotter a kind of “go-as-you-please” mongrel;
nevertheless he is considered by many the noblest achievement of
intelligent American horse breeding. When any one goes in for horse
breeding on either a small or a large scale, whether with one mare
or with one hundred mares, he should, in selecting mates, always
strive for a definite type in the foal. If intelligence and correct
information be guided by experience the results are apt to be
pleasantly satisfactory.
The first cardinal principle of horse breeding was formulated in
England a century and a half ago in the expression: “Like begets
like.” This rule has been followed in the creation and maintenance of
all the great horse types in the civilized world, and singularly enough
all of them, both great and small in size, have descended from Arab
and Barb stock. This concise rule of breeding, “Like begets like,” has
been misunderstood by some who did not take a sufficiently
comprehensive view of it. This likeness does not refer merely to one
thing; not to blood alone, nor to conformation, nor to performance;
but to blood and to conformation and performance, but most of all
to blood. Where blood lines, as to likeness, are disregarded, and
conformation and performance are alone considered, the result is
sure to be a lot of mongrels, some of them, it is true, of most
surpassing excellence, but as a general thing, quite incapable of
reproducing themselves with any reasonable certainty.
The great danger always in breeding horses and other domestic
animals with the idea of improving a type or a family, is that
mongrels may be produced. A mongrel is an animal that results from
the union of dissimilar and heterogeneous blood. An improved and
established reproducing type has hitherto been, and probably always
will be, the result of the mingling of similar and homogeneous blood,
crossed and recrossed until the similar becomes consanguineous.
The Arab and Barb, I have said, are the foundation in blood of all
the great types from the Percheron to the Thoroughbred. To be sure,
other and dissimilar blood was used in the beginning of the making
of all the types, but there was such crossing and recrossing, such
grading up by a selection of mates, that the blood became similar,
and the rule: “Like begets like,” being constantly followed a type
becomes established.
When a type has been established and is of unquestioned value to
the world, it should be preserved most carefully. The French, the
Russians, the Germans and the Austrians do this by means of
Governmental breeding farms. The English accomplish the same
result by reason of the custom of primogeniture and entailed
estates. Continuity in breeding is essential to its complete success.
In this country when a breeder dies, his collection of horses is
usually dispersed by sale to settle his estate. Considering our lack of
Governmental assistance we have done amazingly well to become
the greatest horse-producing country in the world. Our greatness,
however, is mainly due to the vastness of our area, the fertility of
our soil and consequent cheapness of pasturage, and to the high
average intelligence of the American people. We have not exercised
the scientific intelligence in breeding that some European people
have done. So as breeders we have not a great deal to be proud of.
We have done better as to quantity than quality. But we can do
better, and I am sure that we will, for the time is hard upon us when
the four-year-old horse that is not worth $300 in the market will not
be worth his keep.
There is, however, an important public aspect to this question of
improving and maintaining the breed of horses. Without good horses
for cavalry the efficiency of an army is very much crippled. When our
Civil War broke out horseback riding in the North had as an exercise
for pleasure been generally given up, and nine-tenths of the men
who went into the service on the Union side could not ride. On the
other hand, at least seven-tenths of those who went into the
Confederate army could ride. Moreover, the North had a scant supply
of horses fit for cavalry, while in many States of the South such
animals were abundant. Here we had on one side the material for a
quickly-made cavalry, and on the other side practically no material
either in horses or men for such a branch of the army. Critics of the
war attribute the early successes of the South to the superiority of
the cavalry. The Northern side was obliged to wait for nearly two
years before that arm of the service was equal to that of the South.
Thus, this distressful war was probably continued for more than a
year longer than it would have been had the two sides in the
beginning been equally supplied with riders and riding horses. And in
the Japanese-Russian War, now in progress, the Japanese are
hampered dreadfully by their lack of cavalry. They have beaten the
Russians time and again only to let the Russians get away because
of the Japanese inability, from lack of horses and horsemen, to cut
off the line of retreat. It is a most distressingly expensive thing to be
without horses in time of war; unless proper horses are abundant in
time of peace, and the people who own them use them under the
saddle, when war comes there is a scarcity of men who know how to
ride. Good material for cavalry in horses and men is an excellent
national investment.
In addition to my chapters on the breeding of various types I have
added several others on the keeping, handling and using of horses
so that if an owner have only this one book, he may be able to have
at least a little useful information of many sorts and kinds.
THE HORSE IN AMERICA
 CHAPTER ONE
PREHISTORIC AND EARLY HORSES

The paleontologists tell us that the rocks abound with fossils which
show that Equidæ were numerous all over America in the Eocene
period. These were the ancestors of the horse that was first
domesticated, and though there were millions of them on the
Continent of North America in the period mentioned there were no
horses here at all when Columbus made his great discovery, and the
first explorers came to find out what this new India was like. The
remains of the prehistoric horse, when first found, baffled the
naturalists, and he was called by Richard Owen Hyracotherium or
Hyrax-like-Beast. The first fossils discovered showed that the horse
was millions and millions of years ago under twenty-four inches in
stature, with a spreading foot and five toes. In his development from
this beginning the horse furnishes one of the most interesting
examples of evolution. When he had five toes he lived in low-lying,
marshy land and the toes were needed so that he could get about.
He had a short neck and short jaws, as longer were not needed to
enable him to feed on the easily reached herbage. As the earth
became harder, the waters receding, his neck and jaws lengthened,
as it was necessary for him to reach further to crop the less luxuriant
and shorter grasses. He lost, also one toe after another so that he
might travel faster and so escape his enemies. These toes, of
course, did not disappear all at once, but grew shorter, until they
hung above the ground. The “splint bones” on a horse’s legs are the
remains of two of these once indispensable toes, while the hoof is
the nail of the last remaining toe.
As the neck of the horse grew longer and two toes had been
dropped, the legs lengthened and by the time he became what the
scientists call a “Neohipparion” he was about three feet high, and his
skeleton bore a very striking resemblance to that of the horse of to-
day. The teeth also changed with the rest of the animal. In the
earliest specimens discovered the teeth were short crowned and
covered with low, rounded knobs, similar to the teeth of other
omnivorous animals, such as monkeys and hogs, and were quite
different from the grinders of the modern animal. When the marshy
lands of the too-well watered earth had changed into grassy plains
the teeth of the horse also changed from short crowned to long
crowned, so that they could clip the shorter and dryer grasses and
grind them up by thorough mastication into the nutritious food
required for the animal’s well being.
Indeed, the whole history of the evolution of the horse by natural
selection is a complete illustration of adaptation to environment.
Even to-day in the Falkland Islands, where the whole surface is soft,
mossy bogland, the horses’ feet grow to over twelve inches in
length, and curl up so that frequently they can hardly walk upon
them. Where we use horses on hard, artificial roads it is necessary
to have this toe-nail or hoof pared, and protected by shoes.
Where the horse was first domesticated is a matter of dispute upon
which historians are not at all agreed. Some say it was in Egypt,
some select Armenia, and some content themselves with the general
statement that horses were indigenous in Western and Central Asia.
It would be interesting to go into this discussion were it not that it
would delay us too long from the subject in hand. At first they were
used only in war and for sport, the camel being used for journeys
and transportation, and the ox for agriculture. Indeed, I fancy the
horse was never used to the plough until in the tenth century in
Europe. The sculptures of ancient Greece and contemporaneous
civilizations give us the best idea obtainable of what manner of
animal the horse was in the periods when those sculptures were
made. Mr. Edward L. Anderson, one of the most careful students of
the horse and his history, says: “Whether Western Asia is or is not
the home of the horse, he was doubtless domesticated there in very
early times, and it was from Syria that the Egyptians received their
horses through their Bedouin conquerors. The horses of the
Babylonians probably came from Persia, and the original source of all
these may have been Central Asia, from which last-named region the
animal also passed into Europe, if the horse were not indigenous to
some of the countries in which history finds it. We learn that Sargon
I. (3800 B.C.) rode in his chariot more than two thousand years
before there is an exhibition of the horse in the Egyptian sculptures
or proof of its existence in Syria, and his kingdom of Akkad bordered
upon Persia, giving a strong presumption that the desert horse came
from the last-named region through Babylonian hands. It seems
after an examination of the representations on the monuments, that
the Eastern horse has changed but little during thousands of years.
Taking a copy of one of the sculptures of the palace of Ashur-bani-
pal, supposed to have been executed about the middle of the
seventh century before our era, and assuming that the bareheaded
men were 5 feet 8 inches in height, I found that the horses would
stand about 14½ hands—very near the normal size of the desert
horse of our day. The horses of ancient Greece must have been
starvelings from some Northern clime, for the animals on the
Parthenon frieze are but a trifle over 12 hands in height, and are the
prototypes of the Norwegian Fiord pony—a fixed type of a very
valuable small horse.”
The British horse is as old as history. He was short in stature and
heavy of build. New blood was infused by both the Romans and the
Normans, and when larger horses were needed to carry heavily-
armored knights, Flemish horses were introduced both for use and
breeding, so that by the time the Oriental blood was introduced they
had in England many pretty large horses, resembling somewhat the
Cleveland Bay of the present time, though not so tall by three or
four inches, and not so well finished. The horses that were first
brought to America by the English were such as I have suggested.
But the first horses brought hither were not English, but Spanish,
and these were undoubtedly of Oriental blood as were the horses
generally in Spain after the Moslem occupation. But when the
Spanish first came there were no horses, as has been said before, in
either North or South America. Columbus in his second voyage
brought horses with him to Santo Domingo. But Cortez, when he
landed in 1519 in what is now Mexico, was the first to bring horses
to the mainland. They were the wonder of the Indians who believed
that they were fabulous creatures from the sun. The wild horses of
Mexico and Peru were no doubt descended from the escaped war
horses of the Spanish soldiers slain in battle. These escaped horses
reproduced rapidly, and the plains became populous with them. So,
also, with the horses abandoned by De Soto, who returned from his
Mississippi expedition in boats leaving his horses behind. Professor
Osborn of the American Museum of Natural History, has recently
been conducting explorations in Mexico, studying the wild horses
there, and his conclusions are proof of the accuracy of the surmises
which have been made by the historians of the early Spanish
adventurers.
Flanders horses were brought to New York in 1625 and English
horses to Massachusetts in 1629. Previous to these importations,
however, English horses had been landed in Virginia, and in 1647 the
first French horses reached Canada, being landed at the still very
quaint village of Tadousac. Indeed, during all the colonial times there
were many importations as well as much breeding, for on horseback
was the only way a journey could be taken, except by foot or in a
canoe. They needed good serviceable horses, and they obtained
them both by importation and breeding. I suspect that the general
run of horses in the Colonial era in New England and along the
Atlantic seaboard was very similar to the horse that is now to be
found in the province of Quebec, Canada. Every one who has visited
this province knows that these habitant horses are very serviceable
and handy, besides being quite fast enough for a country where the
roads have not been made first class. Harnessed to a calash, an
ancient, two-wheeled, French carriage, they take great journeys with
much satisfaction to their drivers and small discomfort to
themselves. Then the Colonists had the Narragansett pacer, a horse
highly esteemed not only for speed but for the amble which made
his slow gait most excellent for long journeys. When Silas Deane was
the colleague of Benjamin Franklin at the French Court during the
Revolutionary War, he proposed getting over from Rhode Island one
of these pacers as a present for the queen. Indeed, there are those
who maintain stoutly that the virtues of the American trotter as well
as the American saddle-horse came from these pacers. That may be
the case so far as the trotters are concerned, for of the horses bred
to trot fast, as we shall presently see, more are pacers than trotters.
As a matter of fact, however, Barbs are apt to pace, and these
Narragansetts may have had such an origin. In the blood of all our
horse types there is some proportion of Barb blood, and we find
pacers among all except Thoroughbreds. I am sure I never saw a
Thoroughbred that paced, or heard of one.
The history of the American horses with which we are concerned to-
day may be said to have begun after the War of the Revolution. But
the basic stock upon which the blood of the post-revolutionary
importations was grafted was most important and also interesting. It
was gathered from every country having colonies in North America
and blended after its arrival. The Spanish and French blood was
strongly Oriental and mixed kindly with that from Holland and
England. At any rate, when Messenger came in 1788 and Diomed in
1799 there was good material in the way of horse-flesh ready and
waiting to be improved.
 CHAPTER TWO
ARAB AND BARB HORSES

The Arab horse from Nejd and the Berber horse from Barbary are
the most interesting and most important specimens of the equine
race. This has been the case as far back as the history of the horse
runs and tradition makes it to have been so for a much longer
period. And, moreover, these horses in the perpetuation of
established European and American types are as important to-day as
ever. From this Nejdee Arabian and Berber of Barbary have sprung
by a mingling of these ancient bloods with other strains, all of the
reproducing horse types of signal value in the civilized world,
including the Percheron of France, the Orlof of Russia, the charger of
Austria, the Thoroughbred of England, the Morgan of Vermont, Mr.
Huntington’s rare but interesting Clay-Arabians of New York and the
Denmarks of Kentucky. The same is the case with other types or
semi-types, but I only particularize these because the mere mention
of them shows to what uses this singularly prepotent blood can be
put when the two extremes of equine types, and those between the
extremes as well, appear to owe their reproducing quality to the
blood of these handsome little animals that have been bred,
preserved and, so far as possible, monopolized by the nomadic
tribes of Barbary and of Nejd. Nejd comprises the nine provinces of
Central Arabia, while the Berbers wander all through the Barbary
states which consist of Morocco, Algeria, Tunis, and Tripoli, but keep
as remote as possible from what European influence that exists in
that section of the world.
 NIMR (ARAB)

Imported by Randolph Huntington

To most horsemen in America the name of Arab is anathema. They

will have none of him. So far as their light goes they are quite right
in their prejudice. But prejudice in this instance, as in most others, is
the result of ignorance. And I trust in the light of what I shall say
about the Nejdee Arabian, the Berbers of Barbary and the influence
of this blood on the equine stock of the world, I may say this
without any offense. If I give the offense then I preface it with the
apology that I mean none. The truth is that seven out of ten of the
Arabian horses taken into Europe or brought to America have been
inferior specimens and not of the correct breed; twenty per cent at
least have been mongrels and impostures, while of the remaining
ten per cent not more than one per cent have been correct in their
breeding, conformation and capacity to do what was expected of
them.
Some men reading the history of this type and that have persuaded
themselves that a few Arabs selected personally in Arabia would
enable them to beat their competitors as breeders and even to win
against horses that traced back one hundred or two hundred years
ago to Arab and Barb ancestors. Such folly always resulted in costly
disappointment. This folly and consequent disappointment will
become manifest as my narrative proceeds. But before going any
further I do not wish any of my readers to harbor the notion that I
think an Arab would stand any chance on an ordinary race-course to
outrun an English Thoroughbred, or to out-trot in harness or under
saddle an Orlof or an American. I maintain no such absurdity. But I
do maintain that all these types, so that they may preserve their
reproductive capacities, must get from time to time fresh infusions of
this blood. That is why the purely bred Arabian—and the Nejdee is
the purest of all—is as valuable to-day as when the Godolphin Barb
and the Darley Arabian began the regeneration of the English horse
into that wonderful Thoroughbred, which is one of England’s
proudest achievements and most constant sources of wealth.
Historical records dating back to the fifth century show that the best
quality and the greatest number of Arabian horses were to be found
in Nejd. They are also to be found there to-day, and the number has
not, so far as the records speak, increased. They have never been
numerous, as it has never been the policy of the chiefs to breed for
numbers, but for quality. It is not true, however, that a lack of forage
was the restraining cause of this comparative scarcity of horses in
the very section where they have been kept in their greatest
perfection. As a matter of fact, the pasture land of Arabia is
singularly good. The very desert, during the greater part of the year,
supplies sufficient browse for camels; while the pasture grass for
horses, kine, and above all for sheep on the upper hill slopes, and
especially in Nejd, is first-rate. To be sure there are occasional
droughts, but few grazing countries in the world are free from them.
No, the scarcity in horses is not due to a lack of food, but to two
other reasons entirely satisfactory to the chiefs of Nejd. Horses there
are not a common possession and used by all. On the contrary, their
ownership is a mark of distinction and an indication of wealth, as
they are never used except for war and the chase and racing, the
camel carrying the burdens and doing the heavy work of the
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