Chapter 3 Flashcards
Structure of Interest Rates
Why do Debt Security Yields Vary?
Credit risk, Liquidity, Tax Status, Term to maturity
Term Structure of Interest Rates
defines the relationship between the term to maturity and the annualized yield of debt securities at a specific point in time, holding other factors such as risk constant.
Estimating appropriate yield
Yn=Rf,n+Dp+Lp+Ta ( Yield of an n-day debt security = yield of an n-day treasury security, + default premium to compensate for credit risk + liquidity premium + adjustment due to the difference in tax status.
Pure Expectations Theory
term structure of interest rates reflected in the shape of the yield curve is determined solely by expectations of future interest rates.
Impact on expected increase
large supply of funds in the short term market will force yields down. upward sloping curve
expected decline
downward yield curve, with interest decrease expected it ill pressure long term investments. borrowers will want short term funds so they can re-borrow lower interest rates later.
forward rate
estimated in order to represent the markets forecast of future interest rate.
liquidity premium theory
liquidity may be a more critical factor to investors at particular points in time, and the liquidity premium will change over time accordingly. As it does, so will the yield curve.
segmented markets theory
investors and borrowers choose securities with maturities that satisfy their forecasted cash needs.
habitat theory
offers a compromise explanation for the term structure of interest rates.
integrating the theories of term structure
- investors and borrowers select security maturities based on anicipated rate movements. 2. most borrowers are in need of long term funds. 3. investors prefer more liquidity to less.
Uses of the term structure
Forecast interest rates, forecast recessions, investment decisions, financing decisions
why the yield curve changes
conditions may cause short term yields to change in a different manner than long term yields.
