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303 Test 2
Terms in this set (30)
What is the interest rate on:
What is the interest rate?
The "borrowing fee" for the borrower and the "reward" for the lender
Explain "interest rate pass-through
The Fed creates the FFR which in turns dictates the interest rates for other type of lending, explain slow and fast
What was the latest Fed announcement?
Cut QE by $10 billion to a total of $15 billion and end the assest buying program in October
No change to the Federal Funds rate
Borrower receives funds from the lender (principal) for a specific amount of time (maturity) with an additional payment (interest)
Fixed-Payment Loan Contracts
Borrowers receives from the lender and makes periodic fixed payment. These payments include both principal and interest - CAR LOAN
The borrower agree to pay the lender an amount of funds (the coupon payment) until a specificed maturity when the borrower pays the lender the value of the bond (face value)
The borrower immedialte receivves from the lender the purchase price of the bond which is less than the face value F of the bond. In return the borrower agrees to pay the lender the face value of the bond at maturity Treadury Bonds
A dollar paid to you one year from now is worse less than it it worth to you today
PV = CF / (1+i)^n
Yield to Maturity
The interest rate that equates the present value of cash flow payments received from a debt instrument with its value today
Ex ante vs. Ex Post
Ante - Adjusted for expected changes in price level
Post - Adjusted for actual changes in price level
i = ir+pi^e
Nominal interest rate = real interest rate + expected inflation rate
What happens is interest rates rise?
Who is on the supply side?
Who is on the demand side?
What 4 factors determine how the demand curve moves?
Expected Return (+)
What 3 factors effect supply?
Expected Profits (+)
Cost of Borrowing (-)
Government Deficit (+)
What is effect on increased inflation?
Be able to draw graph and show P and i are inversely related
What are the two outcomes of a business cycle expansion?
If demand shifts more than supply i increases
If demand shifts less than supply i decreases
Be able to draw it
What does an increase in expected interest rates and inflation do to the quantity demanded in the bond market?
What three factors explain the risk structure of interest rates?
Default risk level, Liquidity level, taxes
What is a yield curve?
A plot of interest rate to maturity
Increasing means higher LT interest rates
Decreasing means higher ST interest rates
Key assumption of expectation theory
Bonds with different maturities are perfect substitutes - buyers do not prefer one good over over anther
Under expectation theory, when would you purchase a bond?
The interest rate on the longer term bond must be the same as the yield from the short term bond - perfect substitutes
Key assumption of Segmented Markets Theory
Bonds of different maturities are NOT substitutes at all because investors has preferences... markets are segmented
How does the Segmented Markets Theory explain why yield curves slope upwards?
If investors prefer short term assets with lower interest rates, then LT assets will have higher rates to compensate for their lower demand
Three facts regarding yield curves
1) Interests on bonds of different maturities move together
2) When ST rates are lower upwards sloping
When ST rates are higher downward sloping
3) Yeild curves almost always slope upward
Assumption of Liquidity Premium Theory
Bonds of different maturities are partial substitutes. i on a LT bond will equal an average of ST i expected to occur over the life of the LT bond PLUS a liquidity premium that responds to supply and demand conditions for that bond.
What happens to short term interest rates and yield curves according to LP Theory
Slightly Upward Sloping
ST rate rises
ST rate stays the same
ST rate falls moderately
ST rate falls sharply
If the yield curve is downward sloping, what does that tell us?
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