6 Flashcards

Question

What does an upward-sloping yield curve indicate?

Answer 1

An upward-sloping yield curve indicates that long-term rates are above short-term rates. (people expect interest to increase in future)

Answer 2

A flat yield curve indicates that short-term rates and long-term rates are the same.

Answer 3

An inverted yield curve indicates that long-term rates are below short-term rates. (people expect interest to fall)

Answer 4

interest rates on bonds of different maturities move together over time. when short-term interest rates are low, yield curves are more likely to have an upward slope; when short-term rates are high, yield curves are more likely to slope downward and be inverted yield curves almost always slope upward.

Answer 5

Expectations Theory explains the first two empirical facts It does not explain the third fact (yield curves almost always slope upward).

Answer 6

Segmented Markets Theory explains the third empirical fact but not the first two

Answer 7

Liquidity Premium Theory combines Expectations Theory and Segmented Markets Theory to explain all three empirical facts

Answer 8

The interest rate on a long-term bond will equal the average of the short-term interest rates that people expect to occur over the life of the long-term bond. The difference in interest rates of bonds with different maturities is due to the fact that short-term interest rates may have different values at future dates.

Answer 9

Buyers do not prefer bonds of one maturity over another. Bonds are perfect substitutes, meaning that the expected return on bonds of different maturities is equal.

Answer 10

compute the average: 9% +11% / 2 = 10% Expected returns on strategies A and B must be equal, per year.

Answer 11

Fact 1: Interest rates on bonds with different maturities move together over time. The theory explains this by assuming that long-term interest rates are an average of expected future short-term rates. Fact 2: Yield curves tend to slope upward when short-term rates are low and slope downward when short-term rates are high.The theory explains this by assuming that expectations of future interest rates influence long-term rates. Fact 3: The theory does not explain why yield curves usually slope upward. For example, if short-term interest rates are expected to remain unchanged, the yield curve is flat. If short-term rates are expected to fall, the yield curve can become inverted.

Answer 12

bonds of different maturities are not substitutes for each other, and the interest rate for each bond is determined by demand and supply in separate, segmented markets for each maturity.

Answer 13

Investors generally have short desired holding periods and prefer shorter-term bonds because they have less interest-rate risk.

Answer 14

The higher demand for short-term bonds leads to lower interest rates on short-term bonds. To attract investors to longer-term bonds, these bonds must offer higher returns, making the yield curve typically slope upward.

Answer 15

Because investors prefer short-term bonds with less interest-rate risk, there is higher demand for short-term bonds. To attract investors to long-term bonds, these bonds must offer higher interest rates.

Answer 16

The Liquidity Premium Theory is a modification of the Expectations Theory with features of the Segmented Markets Theory. It explains all three empirical facts about interest rates and the yield curve.

Answer 17

Bonds of different maturities are substitutes, but not perfect substitutes.

Answer 18

The interest rate on a long-term bond equals an average of expected short-term interest rates over the bond's life plus a liquidity premium that adjusts based on supply and demand conditions for the bond.

Answer 19

The liquidity premium reflects the additional interest rate required to compensate for the risk of holding longer-term bonds, including the uncertainty about future interest rates and the potential difficulty in selling the bond.

Answer 20

Investors prefer shorter-term bonds because they bear less interest-rate risk. Longer-term bonds are more sensitive to interest rate changes

Answer 21

Investors must be offered a positive liquidity premium (also called a term premium) to compensate for the interest-rate risk associated with holding longer-term bonds.

Answer 22

int = (it+ it+1 +it+2 +⋯+it(n−1))/n + lnt int is the interest rate on the long-term bond. 𝑖𝑡 is the expected short-term interest rate. 𝑙𝑛𝑡 is the liquidity (term) premium.

Answer 23

It is always positive increases with maturity.

Answer 24

The liquidity premium is positive and increases with maturity, meaning longer-term bonds typically have a higher liquidity premium than shorter-term bonds.

Answer 25

Preferred Habitat Theory assumes that investors have a ‘preferred habitat’—a preference for bonds of a particular maturity. They generally prefer short-term bonds but will switch to long-term bonds if the expected return is higher.

6 Flashcards

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