EXAM 2 Flashcards
A dollar paid to you one year from now is less valuable than a dollar paid to you today.
Present Value
The interest rate that equates the present value of cash flow payments received from a debt instrument with its value today.
Yield to Maturity
The same cash flow payment every period throughout the life of the loan.
Fixed-payment loan
Originally sold with coupons printed on them that had to be clipped out and mailed to the bond issuer to receive the interest payment each year.
Coupon Bonds
A bond with no maturity date that does not repay principal but pays fixed coupon payments forever.
Consol or Perpetuity
Known as a zero-coupon bond since such bond makes no coupon payments but is purchased at a discount and then pays the face at maturity.
Discount Bond
The payments to the owner plus the change in a value are expressed as a fraction of the purchase price.
Rate of Return
Yield to maturity only if the holding period equals the time to maturity.
Return
Greater percentage price change that is affected by interest rate changes in the economy.
Distant Maturity
An interest rate that makes no allowance for inflation. The rate you observe.
Nominal Rate
An interest rate that is adjusted for changes in price level so it more accurately reflects the cost of borrowing.
Real Interest Rate
(For price levels) Adjusted for expected changes. Latin
Ex ante
(For price levels) Adjusted for actual changes. Latin
Ex post
Which interest rate more accurately reflects the true cost of borrowing?
Real Interest Rate
What are the 4 primary factors that influence people’s decisions to hold assets?
- Wealth
- Expected returns
- Risk
- Liquidity
The latin term for - Prices and interest rates have a relationship.
Ceteris Paribus
This occurs when the amount that people are willing to buy equals the amount that people are willing to sell at a given price.
Market Equilibrium
The total resources owned by the individual, including assets.
Wealth
The return expected over the next period on one asset relative to alternative assets.
Expected Return
The degree of uncertainty associated with the return on one asset relative to alternative assets.
Risk
The Ease and speed with which an asset can be turned into cash relative to alternate assets.
Liquidity
Determines equilibrium interest rate in terms of the supply of and demand for money.
Keynesian Model
Theory of money demand, where buyers prefer to buy assets with a higher level of liquidity.
Liquidity Preference Model
A higher level of income causes the demand for money of each interest rate to increase and the demand curve to shift right.
Income Effect
A rise in the price level causes the demand for money at each interest rate to increase and the demand curve to shift to the right.
Price-level Effect
The relationship between money supply and nominal interest rates. (Short-run)
Liquidity Effect
An increase in the expected rate of inflation will ____ the expected return on bonds relative to that on _____ assets.
- Reduce
2. Real
An _____ in overall economic activity causes the supply curve for bonds to shift right.
Expansion
Higher government deficits ______ the supply of bonds, shifting the supply curve to the _____.
- Increase
2. Right
The probablity that the issuer of the bond is unable or unwilling to make interest payments or pay off the face value.
Default Risk
The spread between the interest rates on bonds with default risk and the interest rates on treasury bonds.
Risk Premium
A plot of the yield on bonds with differing terms to maturity but the same risk, liquidity, and tax considerations.
Yield Curve
(Curve Characteristics) Long-term rates are above short-term rates.
Upward-slopping
(Curve Characteristics) Short- and Long-term rates are the same.
Flat
(Curve Characteristic) Long-term rates are below short-term rates.
Inverted
Assumes that all risk-free bonds are perfect substitutes.
Expectation Theory
Assumes that risk-free bonds of different maturities are not substitutes at all. Short-term buyers buy short-term, and long-term buyers buy long-term.
Segmented Markets Theory
Assumes that risk-free are substitutes but not perfect.
Liquidity Premium
Long-term bond = ______ of short-term interest rates
Average
Which strategy involves holding two-period bonds.
Buy and Hold Strategy
Which strategy involves holding two one-period bonds.
Roll-over Strategy
The action of buying a security on one market where the prices are low and selling in another where the price is higher.
Arbitrage
Investors have a preference for bonds of one maturity over another.
Preferred Habitat Theory
Bonds of different maturities (but similar default risk) have interest rates that are related to each other via the arbitrage mechanism. Includes the idea that people prefer short-term, but will buy long-term if the return is high enough.
Liquidity Premium Theory
According to pure expectations theory, the yield curve should be ____.
Flat
If corporate bonds are federally backed, then corporate bond rates would _____ and T-bonds would ____.
- Decrease
2. Increase
The segmented markets theory has ______ explaining why instruments of ___________ move together.
- Difficulty
2. Different maturities
Market prices are set by the ____ who can take advantage of the asset.
Buyer
The belief is that investors will make decisions rationally.
Theory of Rational Expectations
The rate of return from holding a security equals the sum of the capital gain on the security plus any cash payments divided by the initial purchase price of the security.
Return
Financial advisors _____ consistently outperform the market.
Cannot
_______ strategy is the most sensible for small investors.
Buy and Hold Strategy
Discount brokers will bring ______ profit as full-service brokers, but with ____________.
- The same
2. Fewer brokerage commissions.
