chapter 6 Flashcards
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Usually applied to debt instruments such as bank loans or bonds; the compensation paid by the borrower of funds to the lender; from the borrower’s point of view, the cost of borrowing funds.
interest rate
Usually applied to equity instruments such as common stock; the cost of funds obtained by selling an ownership interest.
required return
A rising trend in the prices of most goods and services.
inflation
A general tendency for investors to prefer short-term (that is, more liquid) securities.
liquidity preference
The rate that creates equilibrium between the supply of savings and the demand for investment funds in a perfect world, without inflation, where suppliers and demanders of funds have no liquidity preferences and there is no risk.
real rate of interest
The actual rate of interest charged by the supplier of funds and paid by the demander.
nominal rate of interest
A general trend of falling prices.
deflation
The relationship between the maturity and rate of return for bonds with similar levels of ris
term structure of interest rates
A graphic depiction of the term structure of interest rates
yield curve
Compound annual rate of return earned on a debt security purchased on a given day and held to maturity.
yield to maturity (YTM)
A
downward-sloping
yield curve indicates that short-term interest rates are generally higher than long-term interest rates.
inverted yield curve
An
upward-sloping
yield curve indicates that long-term interest rates are generally higher than short-term interest rates.
normal yield curve
A yield curve that indicates that interest rates do not vary much at different maturities.
flat yield curve A yield curve that indicates
The theory that the yield curve reflects investor expectations about future interest rates; an expectation of rising interest rates results in an upwardsloping yield curve, and an expectation of declining rates results in a downward-sloping yield curve.
expectations theory
Theory suggesting that longterm rates are generally higher than short-term rates (hence, the yield curve is upward sloping) because investors perceive short-term investments to be more liquid and less risky than long-term investments. Borrowers must offer higher rates on long-term bonds to entice investors away from their preferred short-term securities.
liquidity preference theory
Theory suggesting that the market for loans is segmented on the basis of maturity and that the supply of and demand for loans within each segment determine its prevailing interest rate; the slope of the yield curve is determined by the general relationship between the prevailing rates in each market segment.
market segmentation theory
A long-term debt instrument indicating that a corporation has borrowed a certain amount of money and promises to repay it in the future under clearly defined terms.
corporate bond
The percentage of a bond’s par value that will be paid annually, typically in two equal semiannual payments, as interest.
coupon interest rate
A legal document that specifies both the rights of the bondholders and the duties of the issuing corporation.
bond indenture
Provisions in a bond indenture specifying certain recordkeeping and general business practices that the bond issuer must follow; normally, they do not place a burden on a financially sound business.
standard debt provisions
Provisions in a bond indenture that place operating and financial constraints on the borrower.
restrictive covenants
In a bond indenture, the stipulation that subsequent creditors agree to wait until all claims of the senior debt are satisfied.
subordination
A restrictive provision often included in a bond indenture, providing for the systematic retirement of bonds prior to their maturity.
sinking-fund requirement
A paid individual, corporation, or commercial bank trust department that acts as the third party to a bond indenture and can take specified actions on behalf of the bondholders if the terms of the indenture are violated.
trustee
