Chapter 6: bond valuation and interest rates part 4 Flashcards Preview

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Flashcards in Chapter 6: bond valuation and interest rates part 4 Deck (33)
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what are the 3 theories of the term structure of interest rates

1. liquidity preference theory
2. expectations theory
3. market segmentation theory


what is the liquid preference theory

refers to the demand for money, considered as liquidity
posits that investors must be paid a liquid premium in order to be compensated for the interest rate risk inherent in holding less liquid, longer-term debt


what is the expectations theory

suggests that longer-term interest rates are the result of expectations of future short-term interest rates or

in other words, the interest rates of various maturities are dependant on each other


what is market segmentation theory

suggest that different markets exist for securities of different maturities that therefore the two ends of the yield curve can have different factors affecting them


what are risk premiums

more risky bonds


what would a BBB- rate corporate bond show

will have their own yield curve
- will plot at higher YTM at every maturity than government bonds
because of the additional default risk that BBBs carry


the yield spread is what

the difference between the YTM on a BB-rated corporate bond and the government of Canada bond of the same maturity


what does the yield spread represent

the default risk premium investors demand for investing in more risky corporate bonds


when does the yield spread widen

during recessions


when does the yield spread narrow

during times of economic expansion


what is RF

is the risk-free rate


more here page 9

page 9


what are debt ratings

risk agencies, such as the dominion bond rating service (DBRS), standard and poors (S&P) and MOddy's assign all publicly traded bonds a risk rating


what are the interest rate determinants

risk, liquidity and bond features


the greater the default risk

the higher the required YTM


the less liquid the bond

the higher the required YTM


call features do what to the YTM

generally increase the required YTM


extendable bonds do what to the YTM

generally have lower required YTMs


Retractable bonds do what to the YTM

generally have lower required YTMs


what are T-bills

short-term obligations of the government


what are the characteristics of T-bills

1. initial term to maturity of one year or less
2. issued at a discount to face value
- face value being paid at maturity
3. the difference between the discounted issue price and the face value is treated as interest income


what is the equation for T-bills

see page 11


what are zero coupon bonds

bonds issued at a discount which pay no coupons and mature at par or face value


what is a good feature about zero coupon bonds

since no coupons are paid, there is no reinvestment rate risk


what is the formula for zero coupon bonds

see 12


what are floating rate bonds

have coupon rates that float with some reference rate such as
1. the yield on treasury bills

since the coupon rate floats, or is variable, the market will typically be close to the bond's face value


what are real return bonds

are issued by the gov. of Canada to protect investors against unexpected inflation


what are some characteristics of real return bonds

each period the face value is gorse dup by the inflation rate
- the coupon is then paid on the grossed up face value


what are Canada savings bonds (CSBs)

issued by the government of Canada as either
1. regular interest bonds (interest paid annually)
2. compound interest bonds (interest compounds over the life of the bond)


is there a secondary market for Canada savings bonds?

instead they are redeemable at any chartered bank in Canada at their face value