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12 Cards in this Set
- Front
- Back
What is a yield curve?
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depicts the relationship between the yield on bonds of the same credit quality but different maturities
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What is a zero-coupon instrument?
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purchased at an amount below its maturity value and pays no interest periodically
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What is the spot rate?
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value of each zero-coupon instrument, determined by knowing the yield on a zero-coupon treaury with the same maturity; relationship between spot rate and maturity is the spot rate curve
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What is a forward rate or an implied forward rate?
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a future interest rate calculated from either the spot rates or the yield curve
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What is pure expectations theory?
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forward rates exclusively represent expected future rates
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What are the consequences of a percieved rise in interest rates?
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1. long term bond prices down; demand for short term bonds up
2. long term bonds sold or shorted to buy short term 3. borrowers borrow now |
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What does the pure expectations theory ignore?
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future rates are uncertain
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What are the two risk associated with bond investment?
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1. uncertainty about the price of the bond at the end of the investment horizon (price risk; longer the maturity the greater the risk
2. reinvestment risk (don't know how return will differ in different periods) |
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What are the interpretations of the pure expectations theory?
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1. 5yr, 12yr, 30yr all have same return over five year period
2. all lengths have same 6 month returns (local expectations) 3. return of rolling over short-term bonds to some investment horizon will be the same as zero-coupon bond with a maturity that is the same as that investment horizon |
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What is the liquidity theory?
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yield curves will be upward sloping to reflect an increasing liquidity premium as a result of longer and longer maturities
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What is the preferred habitat theory?
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shape of yield curve is determined by expectations of future interest rates and a risk premium; people invest for horizon/habitat that suits them (say retirement); people want to avoid risk (reinvestment risk)
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What is market segmentation theory?
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yield curve is determined by supply of and demand for securities within each maturity sector; people are not willing to shift (segmented) from one maturity sector to another to take advantages of favorable conditions; people are completely risk averse
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