Chapter 6: The Risk and Term Structure of Interest Rates Flashcards
default-free bonds
bonds with no default risk (Treasury Bonds)
risk premium
the spread of the interest rates on bond with default risk vs ones that are default free
risk sharing
asset transformation
asset transformation
selling low-risk assets to fund the purchase of higher-risk assets
Carry trade
borrow short term, lend long tern
risk structure of interest rates
the relationship between bonds that have the same term to maturity and different interest rates
term structure of interest rates
the relationship between interest rates on bonds with a different terms to maturity
junk bonds
bonds with ratings below Baa or BBB which have higher default risk and have been dubbed speculative grade or high-yield bonds
yield curve
a plot of the yields on bonds with differing terms to maturity but the same risk, liquidity, and tax considerations
parallel shifts
when the yield curves of short-term bonds and long term move together
what impacts the shape of today’s yield curve?
- treasury deficits
- an increase of federal funds rate
- the federal reserve is decreasing balance sheet (quantitative tightening)
- Euro zone low rate policy
- deflation/recession fears
- flight to safety
- slowing global economy
- rising inflation
Treasury bonds
- default free
- most liquid bond market
- taxable interest
Muni Bonds
- default risk
- less liquid
- interest is exempt from federal income tax
After-tax expected return equation
return = interest rate (1 - tax)
what is the relationship between interest rates and bonds of different maturities?
interest rates for different maturities move together over time
