Interest Rates Flashcards
How did the Fed respond to the Great Recession?
By lowering the target for the fed funds rate to zero, and then engaging in a process of quantitative easing by purchasing longer-term securities.
How are assets valued?
By determining the future expected cash flow discounted at a rate that reflects the riskiness of the cash flow.
What is Portfolio Theory?
It assumes that a rational investor seeks to minimize risk while maximizing reward.
What is a hurdle rate?
The rate of return an investor requires, above which the investment makes sense and below which it does not.
What does a normal sloping yield curve represent?
An interest rate environment where interest rates in the short term are lower than those in long term.
What does a flat yield curve represent?
An interest rate environment where there is little difference between long-term and short-term interest rates. This means that investors are not rewarded proportionately for holding longer-term assets, in comparison to a normal yield curve environment.
What does an inverted yield curve represent?
Investors are paid a higher return on short-term assets then on long-term assets. This may reflect a negative outlook on the economy.
What are the two components of a long-term interest rate?
1) the spot interest rate that market participants currently expect to prevail at some date in the future and 2) the additional compensation that investors require for the risk of holding longer-term instruments (term premium).
What happens if demand for long-term securities rises?
If the demand rises relative to supply, investors will generally accept less compensation to hold longer-term securities, which means the term premium will decline.
What are the four reasons that demand for long-term issues could increase?
1) LT issues are more stable due to less volatility in the economy. If investors think these market conditions will continue, they may believe that less compensation for is need to justify holding LT issues. 2) Increased intervention in currency markets by governments have put downward pressure on yields. 3) Pension funds are required to be more fully funded because of new financial reforms. 4) Lack of supply.
What are treasury securities?
A debt instrument issued by the Treasury depart that represents direct obligations of the U.S. Government (full faith and credit). Can come in the form of Treasury bills, notes or bonds.
Why are they important?
The treasury yield curve is a benchmark for fixed income securities across the spectrum of debt securities. They are unique because they have virtually nonexistent default risk and tight bid offer spreads.
What are the three goals of the Treasury?
1) Achieve the lowest possible debt service cost, 2) Ensure access to unlimited credit in times of war or emergencies, 3) Promote efficient capital markets.
How are Treasuries used?
1) By the Fed to carry out monetary policy, 2) By foreign currency boards as reserves for dollar-linked currencies, 3) as the default risk-free U.S. Benchmark 4) As the yield determinate for pension funds, 5) By portfolio managers to hedge risk, 6) As a benchmark in determining the required return from riskier investments.
What are primary dealers?
Banks and securities brokerages that trade in U.S. Government securities directly with the Fed. As of 2015, there were 22 primary dealers (TD Securities was added).
