Chapter 6 Flashcards
What is rick structure of interest rates?
Relationship among interest rates
What is the term structure of interest rates?
Relationship among interest rates on bonds with different terms to maturity
What are two features of interest rate behavior for bonds with the same maturity?
Interest rates on different categories of bonds differ from one another in a given year
Spread between interest rates varies over time
Who has no default risk?
Us treasury
default free bonds
What is an attribute that influences a bonds interest rate is ?
Default risk
What is risk premium?
Spread between interest rate of bonds with default risk and default free bonds
How much additional interest is needed for people to hold that risky bond
What does a bond with default risk have?
Positive risk premium, higher default risk=higher risk premium
What do credit-rating agencies do?
Provide information on if a company will default on their loan
What is an investment-grade security?
Low risk of default Baa or above
What is a junk bond?
High default risk, lower than Baa
high yield bonds
Another attribute to interest rate?
Liquidity
U.S. treasury bonds compared to corporate conds
What are municipal bonds lower interest rates than treasury bonds?
Exemption from federal taxes
What three things determine risk structure of interest rates?
Default risk, liquidity, income tax treatment
What happens as the bond’s default risk increases?
Risk premium rises
What happens with higher liquidity?
Lower interest rates
What is a yield curve?
A plot of yields on bonds with differing terms to maturity but the same all other factors
What must a theory of term structures include?
Explaining why curves take on different shapes
why interest rates of bonds with different maturities move together
When short-term interest rates are low yield curve is likely to upward slope
Yield curves almost always slope up
Liquidity premium
Explains all three
What is the expectations theory?
Interest rate on a long term bond will equal an average of the short-term interest rates that people expect over the lifetime of a bond
do no prefer bonds of one interest rate over another
What is perfect substitutes?
The bonds of different maturities must have equal returns
What happens if the curve is upward sloping?`
Short term interest rates will rise
What happens if curve is downward sloping?
Short term interest rates are expected to fall
When the curve is flat?
Short term interest rates are not expected to change
What is unique about segmented market theory?
Sees markets for different maturity bonds as separate and segmented
Bonds with other maturities do not affect each bonds interest rate
Assume there is no substitute
Curve slopes up because demand for long term bonds is lower than short term, therefore lower prices and higher interest rates
What is the liquidity premium theory?
Interests rates on a long term bond will equal an average of short term interest rates plus liquidity premiums
Bonds are related but people can prefer one over the other
What do investors prefer?
Short term bonds
