Chapter 3 Flashcards
What is the definition of a yield curve?
A yield curve shows how interest rates vary with time to maturity
What are the different basic yield curve shapes?
Positive (normal)
Negative (inverse)
Flat
Humped
What is the formula for simple interest?
I = PV x r x t
What is the formula for future value with simple interest?
FV = PV + I
What is the formula for calculating the discounted/Present value formula?
PV = FV(1 - d x t) where d is the discount rate
What is the formula for calculating the discount amount?
D = (FV x d x t) where d is the discount rate
What is a required rate of return?
The minimum rate of return an investor will accept to make the investment.
What is opportunity cost?
The value that an investor will forego by choosing a particular course of action.
What does the yield curve show?
It shows how interest rates vary with time to maturity
What are the 4 basic shapes of the yield curve?
1) Positive (normal)
2) Negative (inverse)
3) Humped
4) Flat
When does flat and humped yield curves occur?
They occur when the shape of the yield curve is changing from normal to inverse and vice versa
What influences the short maturity section of the yield curve?
The monetary policy
What happens to the short maturity section of the yield curve when the monetary policy is restrictive?
Short-term interest rates are forced higher creating a negative or flat yield curve
What are the 3 theories that explain the shape of the yield curve?
1) Expectations theory - reflects market’s expectations of future short-term rates
2) Liquidity theory - longer term bonds must offer a yield premium over short term bonds
3) Market segmentation - Some investors have a predetermined demand for particular maturities
What is annuity?
A sequence of equal payments.
What is ordinary/deferred annuity?
Payments occur at the end of each period
What is an annuity due?
When payments are made at the start of each payment interval
