Chapter 4 Interest Rate, Stock Index, and foreign Currency Futures Flashcards
Debt Securities
Sold by an issuer as means to raise money.
Who is the borrower of debt securities?
the issuer
The buyer of the debt security is:
the lender and expects to earn interest and have the principal returned when the debt security matures.
Who issues debt
- Federal Governments
- Municipal governments
- corporations
Coupon Rate
annual payments paid by the issuer relative to the bonds face (par) value.
If interest rates fall, bond prices:
rise
Default risk
the risk that the issuer may lack the means to pay interest and principal on its debt.
Normal (positive) yield curve
Lower yields for short-term debt and higher yields for long-term debt are typical, and the curve they produce when depicted on a graph is a normal (positive) yield curve.
Why does a normal (positive) yield curve have an upward or positive slope?
this is normal because of risk: The shorter the maturity, the less volatile (hence safer): the longer the maturity, the more volatile (hence riskier).
Inverted (negative) yield curve
indicates that short term debt securities provide higher yields than long-term debt securities.
When does an inverted yield curve typically occur?
temporary phenomenon when the supply of money is tight.
Positive carry
when the short term interest rates are lower than the long term interest rates, thereby creating a positive yield curve.
Why are interest rate future prices progressively discounted on a monthly basis in the normal, positive carrying charge environment?
Financial institutions can profitably offer lower quotes on the more distant money market vehicles, thereby creating a situation where the further-out contracts are quoted at a discount to the nearbys.
Inverted (negative) yield curve
as the term of the security increases, the yield decreases
Humped yield curve
a humped curve occurs when short-term and long-term yields are nearly equal and medium-term yields are higher than short-term and long-term.
Positive yield curve summary
Long term rates greater than short term rates
negative yield curve
long term rates less than short term rates
flat yield curve
long term rates and short term rates about the same
humped yield curve
short term and long term yields are nearly equal, and medium-term yields are higher.
Why are short term yields more volatile than long term
interest rates on new 3 month t-bills vary from week to week, depending on economic expectations. Conversely, a 20 year bond yields react less to daily events because short-term events mean little relative to the bonds 20 year life.
Why are long term prices more volatile
Interest rate changes have little effect on the price of short-term bills because they mature quickly. Because of the long time framce and the subsequesnt risk to the buying power of the bond income and principal due to inflation, long-term securities have greater interest rate risk.
Short term debt obligations 2
t-bills
eurodollar futures
T-Bill and Eurodollar Futures similar features (4)
Contract size based on $1 million par values
- have three-month maturities
- are priced at a discount and mature at par (100%);
- Reflect that the underlying commodity is a discount debt obligation.
What is the yield of a t-bill
difference between the discount price and par.
