W2

Question 1

Risk structure of interest rates def

Answer 1

When bonds with the same maturity date have different interest rates

Question 2

Risk, liquidity, and income tax are factors that play a role in determining the risk structure.

Question 3

Default risk premium

Answer 3

risk premium = i_C - I_T

Question 4

Corporate bonds: risk bearing bond
Treasury bond: default-free bond

Question 5

Investment grade bonds: Baa (or BBB) and above
Junk bonds: below Baa (or BBB)

Question 6

US municipal bonds may have tax exemptions (which raises relative RET)

Question 7

Yield curve def

Answer 7

A plot of the yield on bonds with different terms to maturity, but the same risk, liquidity and tax considerations

Question 8

Important facts about interest rates

Answer 8

1. Interest rates on bonds of different maturities move together over time.
2. The yield curves tend to have an upward slope when short-term interest rates are low and a downward slope when short-term interest rates are high.
3. A yield curve is typically upward-sloping.

Question 9

The expectations theory

Answer 9

Key assumption: Bonds of different maturities are perfect substitutes.
Explains: Fact 1 & 2

Question 10

Buy and roll strategy

Answer 10

expected return= ((1+i_2t )(1+i_2t )-1)/1=2i_2t+〖(i_2t)〗^2

Question 11

Rolling strategy

Answer 11

expected return= ((1+i_t )(1+i_(t+1^e ) )-1)/1=i_t+i_(t+1^e )+i_t (i_(t+1^e ))

Question 12

The segmented markets theory

Answer 12

Key assumption: Bonds of different maturities are not substitutes at all.
Explains: Fact 3

Question 13

The liquid premium theory

Answer 13

Key assumption: Bonds of different maturities are substitutes, but they are not perfect substitutes.
Explains: all 3 facts
i_nt=(i_t+i_(t+1)^e+i_(t+2)^e+i_t(n-1)^e)/n+l_nt