Chap 7: Fixed income pricing and trading Flashcards
Three theories that attempt explain the shape of the yield curve are the…..
Expectations Theory,
Liquidity Preference Theory
Market Segmentation Theory
This theory says that current long-term interest rates foreshadow future short-term rates. According to this theory, investors buying a single long-term bond should expect to earn the same amount of interest as they would buying two short-term bonds of equal combined duration. The theory implies that the shape of the yield curve indicates investor expectations about future interest rates.
Expectations Theory
The _________ theory holds that an upward sloping yield curve indicates an expectation of higher rates in the future, whereas downward sloping curve indicates that rates are expected to fall.
Expectations Theory
According to the ________, investors prefer short-term bonds because they are more liquid and less volatile in price. An investor who prefers liquidity will venture into longer-term bonds only if there is sufficient additional compensation for assuming the additional risks of lower liquidity and increased price volatility.
liquidity preference theory
The __________postulates that the yield curve represents the supply of and demand for bonds of various terms, which are primarily influenced by the bigger players in each sector. This theory can explain all types of yield curves, including normal, upward-sloping curve, and inverted (downward sloping) curve, and a humped curve.
market segmentation theory
This theory does not explain a flat or downward sloping yield curve.
Liquidity Preference Theory
This theory can explain all types of yield curves, including normal, upward-sloping curve, and inverted (downward sloping) curve, and a humped curve.
Market Segmentation Theory
The terms ______ and _______ are often used interchangeably, with both meaning a rate of return on an investment.
Interest Rate and Bond Yield
Therefore, as interest rates rise, bond yields _______, but bond prices fall.
also rise
As interest rates fall, bond prices _____
Rise
As bond prices rise, bond yields ______
Fall
As interest rates fall, bond yields ______
Fall
Remember that the _____ rate does not change over the life of the bond
Coupon
______ -term bonds are more volatile in price, therefore their prices are more sensitive to interest rates
Long term
______ coupon bonds are more volatile in price, therefore, their prices are more sensitive to interest rates.
Lower
_______ yielding bonds are more volatile in price, therefore, their prices are more sensitive to interest rates.
Lower
If we expect interest rates to increase, what type of bonds do we want to be in?
Short term bonds with higher coupons because they are less volatile
If we expect interest rates to decrease, what type of bonds do we want to be in?
Long term bonds with lower coupons because they are more volatile
