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17 Cards in this Set

  • Front
  • Back
Factors Affecting Nominal Interest Rates
Inflation, Real Interest Rate, Default Risk, Liquidity Risk, Special Provisions, Term to Maturity
Inflation (IP?)
One of six factors affecting nominal interest rates...
continual increase in price of goods/services
Real Interest Rate (RIR)
One of six factors affecting nominal interest rates...
Nominal interest rate int he absence of inflation
Default Risk
One of six factors affecting nominal interest rates...
Risk that issuer will fail to make promised payment
Liquidity Risk
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
Special Provisions
One of six factors affecting nominal interest rates..
E.g., taxability, convertibility, callability, putability
Term to Maturity
One of six factors affecting nominal interest rates..
Just how long it is until the asset matures lalala
Inflation and interest rates: Fisher Effect
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)
Default Risk and Int. Rates
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...
Tax Effects: The tax exemption of interest on municipal bonds
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
Term to maturity and Interest Rates : Yield Curve
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
Unbiased Expectations Theory
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)
Liquidity Premium Theory
-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
Market Segmentation Theory
-Investors have specific maturity preferences and will generally demand a higher premium

-AKA Market Segmentation Hypothesis
Pure Expectations Hypothesis
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.
Assumptions of the PEH
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
Forecasting Interest Rates Using the PEH
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)