Chapter 3 Financial Markets & Institutions, Treasury Bond Yield & Interest Rates Flashcards
What is a Financial Market
A financial market is a place where individuals and organisations wanting to borrow funds are brought together with those with a surplus of funds.
What are the types of Financial Markets
- Primary & Secondary Markets
2. Public & Private Markets
What is a balance sheet
It provides a snapshot of the company’s financial position at one point in time
What is a income statement
It summarises the firm’s revenues and expenses over a give period of time
What four factors affect the level of interest rates? [TERP]
- Time Preference of Consumption
- Expected Inflation
- Risk
- Production Opportunities
What is r*
R* is the real risk free rate of interest when there is zero expected inflation
what is r(RF)
R(f) is the rate of interest on treasury securities.
What is the difference between r and r(f)
The difference is r takes into account Default Risk premium (DRP) and Liquidity premium which is absent in R(rf) because R(rf) is the treasury yield which does not have default or liquidity risks.
What is the Inflation Premium Formula
IP = (Sum of expected inflation) / Total number of periods
What are the three factors from the bottom up that makes up a treasury yield curve
Bottom: Risk Free Rate (r*)
Middle Inflation premium (IP)
Top: Market Risk Premium (MRP)
Is the yield curve upwards sloping?
Yes, the yield curve is often upward sloping due to an increase in expected inflation and increasing maturity risk premiums.
IT CAN BE DOWNWARD sloping as well if inflation or MRP is negative.
What is the difference between treasury yields and corporate yields?
Corporate yields are higher than treasury yields because they have to take into account the default risk premium and the liquidity premiums of the corporations that offer them.
What are the macroeconomic factors affecting interest rates?
- Government Federal Policy
- Government Budget Deficit/Surplus
- Business Activity
- International Factors like trade deficits
