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17 Cards in this Set
- Front
- Back
Factors Affecting Nominal Interest Rates
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Inflation, Real Interest Rate, Default Risk, Liquidity Risk, Special Provisions, Term to Maturity
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Inflation (IP?)
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One of six factors affecting nominal interest rates...
continual increase in price of goods/services |
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Real Interest Rate (RIR)
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One of six factors affecting nominal interest rates...
Nominal interest rate int he absence of inflation |
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Default Risk
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One of six factors affecting nominal interest rates...
Risk that issuer will fail to make promised payment |
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Liquidity Risk
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One of six factors affecting nominal interest rates..
Risk that a security can not be sold at a predictable price with low transaction cost on short notice |
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Special Provisions
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One of six factors affecting nominal interest rates..
E.g., taxability, convertibility, callability, putability |
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Term to Maturity
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One of six factors affecting nominal interest rates..
Just how long it is until the asset matures lalala |
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Inflation and interest rates: Fisher Effect
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The interest rate should compensate an investor for both expected inflation and the opportunity cost of foregone consumption (the real rate component)
i=RIR + Expected (IP) or... RIR = i - Expected (IP) |
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Default Risk and Int. Rates
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The risk that a security's issuer will default on that security by being late on or missing an interest or principal payment
DRP>j = i>jt - i>Tt I think those mean the Deafult premium is the rate on the asset minus the rate on a trasury asset we'll look into that further... |
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Tax Effects: The tax exemption of interest on municipal bonds
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Interest Payments on municipal securities are exempt from federal taxes and possibly state and local taxes. Therefore, yields on "munis" are generally lower than on equivalent taxable bonds x (1-State Tax Rate - Fed. Tax Rate)
Interest on Muni = Interest on Corp |
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Term to maturity and Interest Rates : Yield Curve
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Yield Curve can have positive slope (i.e. rates increase with time to maturity (most common), or no slope (no effect on rates o time to maturity), or negative slope (the more the time to maturity, the less the required rate) the previous two are rare and are generally anomalous in financial history
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Unbiased Expectations Theory
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at a given point in time, the yield curve reflects the market’s current expectations of future -short-term rates
-AKA Pure Expectations Hypothesis (PEH) |
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Liquidity Premium Theory
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-investors will only hold long-term maturities if they are offered a premium to compensate for future uncertainty in a security's value
-AKA Liquidity Preference Hypothesis |
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Market Segmentation Theory
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-Investors have specific maturity preferences and will generally demand a higher premium
-AKA Market Segmentation Hypothesis |
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Pure Expectations Hypothesis
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Contends shape of yield curve depends on investor's expectations about future interest rates
If interest rates are expected to increase, LT rates will be higher than ST rates, and vice-versa. Thus, the yield curve can slope up, down, and even bow. |
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Assumptions of the PEH
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1. The maturity risk premium for Treasury securities is zero
2. LT rates are an average of current and future ST rates 3. If E is correct, you can use the yield curve to "back out" expected future interest rates |
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Forecasting Interest Rates Using the PEH
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Forward rate is an expected or "implied" rate on a security that is to be originated at some point in the future using the unbiased expectations theory (equation on slide 14 of these things chickity check it out biatch)
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