Lecture 4 Flashcards
When a bond is further from maturity, its price is __ sensitive to changes in yield
More sensitive
Duration is a measure of what?
Risk
How does a high coupon affect duration?
Reduces duration
What are two measures of duration?
- Macaulay duration
- Modified duration
Macaulay duration is measured in…
years
How do you calculate modified duration?
change in price / change in yield
Yield curves typically slope…
upwards
Why do yield curves typically slope upwards?
Investors want higher yields to compensate for lower liquidity of long-maturity bonds
When do yield curves invert?
When interest rates are very high & therefore expected to fall
What is pure expectations theory?
Yield curves are determined entirely by interest rate expectations
If the 1 year yield is 5% and the 2 year yield is 4%, what is the 1 year forward rate?
3%
What is liquidity preference theory?
Yield curves slope upwards because high maturity = low liquidity
What are the explanations for yield curves?
- Pure expectations theory
- Liquidity preference theory
- Segmented markets
What does ‘segmented markets’ mean?
Lenders have a ‘preferred habitat’ e.g. a bank that obtains funds from short-term borrowing may prefer short-term lending
Are government or commercial bonds more liquid?
Government bonds = more liquid