Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

FN1 corporate finance > chapter 6: interest rate determinants > Flashcards

chapter 6: interest rate determinants Flashcards

You may prefer our related Brainscape-certified flashcards:
Series 66 flashcards SIE Exam flashcards Series 63 flashcards Series 79 Top-Off Exam flashcards Series 7 Top-off Exam flashcards CFA flashcards Series 65 flashcards
1
Q

what are base interest rates usually quoted on

A

an annual percentage basis

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

common to refer to changes in interest rates in terms of

A

basis points or 1/100th of 1%

ex 250 basis point is 2.5%

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

a decrease of 10 basis points indicates what

A

that interest rates declined by 0.1%

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

interest is the price of

A

borrowed money

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

interest is determined by

A

the laws of supply and demand

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

if demand for loanable funds rise

A

the interest rates rise

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

if the demand for loanable funds falls

A

the interest rates fall

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

what are nominal interst rates

A

rates charged for lending today’s dollars in return for getting dollars back in the future, without taking into account the purchasing power of those future dollars

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

one of the most important factors in determining nominal interest rates is

A

the expected rate of inflation

- this determins the purchasing power of those future dollars

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

what is the risk free rate

A

the rate of return on risk-free investments

  • often used as the base interest rate
  • it is an abstract concept, and usually the yield on short term gov. T-bills is used as a proxy for practical purpsoes
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

what is the risk free rate made up of

A
  1. the real rate
    - compensation for deferring consumption
  2. expected inflation rate
    - compensation for the expected loss of purchasing power over the term of the short-term T-bill
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

what is real rate

A

compensation for deferring consumption

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

what is expected inflation rate

A

compensation for the expected loss of purchasing power over the term of the short-term T-bill

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

T-bills yields are considered

A

risk free because they possess no risk of default

  • gov. controls the bank of Canada and can always have it buy any bonds that are issued
  • also their term to maturity is short
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

what does risk free rate =

A

real rate + expected inflation

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

what is the risk free rate often called

A

the fisher effect

  • after Irvine fisher
  • describves how investors attempt to protect themselves form the loss in purchasing power caused by an inflation by increasing their required nominal yield
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

estimating the real rate of return
if T-bills rates are currently 4.5% and the expected level of inflation is 2%, estimate the approximate real rate of return

A

4.5 -2 = 2.5%

18
Q

Canadian interest rates are heavily influenced by what

A

changes in interst rates in other countries

19
Q

macroeconomic factors also play an important role in

A

both domestic and global rates

20
Q

what is IRP interest rate parity theory

A

foreign exchange forward rates will be established that equalize the yield an investor can earn whether investing domestically or in a foreign place
- ex. a country with both high inflation and high interst rates will have a depreciating currency

21
Q

the term structure of interest rates is

A

the set of rates (YTM) for ALL maturities of a given risk calss of debt securities (eg. gov of Canada bonds) at a given POINT IN TIME

22
Q

when plotted on a graph the term structure of interest rates the result is

A

called a yield curve

23
Q

what are the 3 typical shapes of a yield curve

A
  1. upwardsloping,
  2. normal
  3. downward sloping
24
Q

what is the term strucuture of interest rates

A

the relationship b/w interst rates and the term to maturity on underlying debt instruments

25
Q

what is the yield curve

A

the graphic representation fo the term structure of interest rates, based on debt instruments from the same issuer

26
Q

the yield curve must be constructed based on

A

interest rates on debt instruemtns that are from the same issuer
otherwise, default risk and other risk factors in addition to maturity differntials, will affect the difference in yields

27
Q

yield curves are usally

A

upward sloping

28
Q

what are the 3 most common theories fo the yield curve

A
  1. expections theory
  2. market segmentaitons theory
  3. liquidity preference theory
29
Q

what is expections theory

A

longer-term interest rates are the result of expectations of future short-term interest rates
in otherwords
the interst rates of various marturities are dependant on each other
upward yield curve - would say expecting interst rates ot increase

30
Q

what is market segmenation theory

A 
distinct markets (or market segments) exist for interest rate securities of various maturities and 
- that the rates are determined within these independent market segments by the forces of supply nd demand within that market
31
Q

what is liquidation theory

A

investors prefer short term debt instruments
- because they exhibit less interst rate risk, while debt issuers prefer to lock in borrowing rates for logner periods to avoid the risk of having to refinance at higher rates
(short term insturments = more liquid instruments)
- long term debts are riskier than short term
- expect a premium or higher rate for taking on a long-term bond
yild curbves are generally upward slopping because long term rates will be higher
- this theory does not properly account for downward sloping or flat term strucutures

32
Q

what is risk premium

A

investors expect extra compensation for assuming additional risk
- require a higher rate of return

33
Q

what is maturity yield differential

A

refers to the term structure impact

34
Q

what is the spread

A

difference in yield tha compensates the investor for the assumption of additional risks

35
Q

what may the spread include

A
  1. default or credit risk (the risk associated with the bond issuer and its ability to pay
  2. liquidity
  3. issue specific features
36
Q

yield spread is the difference

A

bw the YTM on a BBB-rated corporate bond and the gov of Canada bond of the same maturity and it represents the default risk premium investros demand for investing in more risky corp. bonds

37
Q

what are debt ratings

A

ratings assigned by professional debt-rating services after detailed analysis of bond issuers to determine their ability to sustain the required interest and principal payments

38
Q

what is the yield spread during recession and economic expansion

A

widen during recession

narrow during economic expansion

39
Q

what is investment grade debt

A

debt obligation with a credit rating of AAA, AA, A or BBB

40
Q

what is speculative debt

A

debt that is not investment grade

  • rated below BBB or Baa
  • also called high yield debt, junk bonds or low grade debt
41
Q

is all debt rated?

A

no, some investors don’t require it

FN1 corporate finance (44 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions