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Flashcards in Exam 2 Deck (113)
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1

Interest rate levels

Price of capital. Borrows are willing to pay and lenders are going to recieve

2

What are the four factors that affect interest rates?

Production opportunities, time preferences for consumption, risk, and expected inflation

3

Time preferences for consumption

Supply side. More in future high supply =lower interest rate

4

Risk

Higher risk=higher interest

5

Expected inflation

High inflation = high IR

6

R*

Real risk free rate of interest

7

Rrf

The nominal rate of interest on treasury securities

8

Rrf=

R*+IP

9

Interest rate equation

R*+IP+DRP+LP+MRP

10

R

Required return on a debt security

11

DRP

Default risk premium. Chance for borrower not to make payment

12

LP

Liquidity premium. Convertibility to cash at fair market value

13

MRP

Maturity risk premium. Price of long term bonds changes over time as interest rate changes. Risk of capital loss

14

Short term treasury

IP

15

Long term treasury

IP and MRP

16

Short term corporate

IP DRP LP

17

Long term corporate

IP MRP DRP LP

18

Term structure

Relationship between interest rates and maturities

19

Yeild curve step one

Find the average expected inflatiob rate over years

20

Yeild curve step two

Find the appropriate maturity risk premium. .1%(t-1)

21

Yeild curve step 3

Add the premiums to r*

22

Upward sloping yeild curve

Due to an increase in expected inflation and MRP

23

Corporate yeild curves

Are higher than that of treasury securities though not parallel to t-curve

24

The spread between corporate and treasury yeild curves

Widens as fhe corporate bond rating decreases

25

Since corporate yields include a DRP and LP the yield spread can be calculated as

Corporate bond yield-Treasury bond yield
DRP+LP

26

Investment grade bonds

BBB and higher. Investment companies can only invest in these

27

Junk bond

BB and lower

28

Pure expectations theory

Contends that the shape of the yield curve depends on investors expectations about future interest rates. IR increase LT rates will be higher than ST rates

29

Assumptions of pure expectations

MRP for T-securities is zero, LT rates are an average of current and future ST rates, use to guess future rates

30

Macro factors that influence IR

Federal reserve policy, federal budget deflicits or surpluses, international factors, level of business activity