Risk and return structure of interest rates (chapter 6)

0.0(0)
studied byStudied by 0 people
0.0(0)
full-widthCall Kai
learnLearn
examPractice Test
spaced repetitionSpaced Repetition
heart puzzleMatch
flashcardsFlashcards
GameKnowt Play
Card Sorting

1/11

encourage image

There's no tags or description

Looks like no tags are added yet.

Study Analytics
Name
Mastery
Learn
Test
Matching
Spaced

No study sessions yet.

12 Terms

1
New cards

Default risk

probability that the insurer is unable or unwilling to make interest payments or pay off the face value

2
New cards

Risk premium

the spread between the interest rates on bonds with default risk and the interest rates on Canada bonds

3
New cards

Income tax considerations

interest payments on municipal bonds are exempt from federal income taxes

4
New cards

Liquidity premium

additional yield investors require to hold a less liquid asset

5
New cards

Upward sloping yield curve interpretation

long term interest rates > short term interest rates

typical

6
New cards

Flat yield curve interpretation

long term interest rates are equal to short term interest rates

7
New cards

Inverted yield curve interpretation

long term interest rates < short term interest rates

signals economic recession

8
New cards

3 key facts about interest rates

  1. Interest rates on bonds of different maturities move together over time

  2. When short-term rates are low, yield curves are more likely to have an upward slope, and more likely inverted when rates are high

  3. yield curves almost always slope upward

9
New cards

Expectations theory

  • Explains facts 1 and 2

  • The long-term interest rate on a bond will equal an average of the expected short-term interest rates over the long-term bond’s lifetime

  • Bond holders do not have maturity preferences (perfect substitutes)

10
New cards

Segmented markets theory

  • Explains only fact 3

  • investors have maturity preferences

  • investors generally prefer bonds with shorter maturities that have less interest-rate risk

11
New cards

Liquidity preference theory

  • Explains all 3 facts

  • Bonds of different maturities are partial (not perfect) substitutes

  • The interest rate on a long-term bond will equal the average of short-term interest rates over the long-term period PLUS a liquidity premium

12
New cards

Preferred habitat theory

  • investors have a preference for bonds of one maturity over another

  • they will be willing to buy bonds of different maturities, only if they earn a somewhat higher expected return

  • investors are likely to prefer short-term bonds over long term bonds