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12 Cards in this Set

  • Front
  • Back
What is a yield curve?
depicts the relationship between the yield on bonds of the same credit quality but different maturities
What is a zero-coupon instrument?
purchased at an amount below its maturity value and pays no interest periodically
What is the spot rate?
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
What is a forward rate or an implied forward rate?
a future interest rate calculated from either the spot rates or the yield curve
What is pure expectations theory?
forward rates exclusively represent expected future rates
What are the consequences of a percieved rise in interest rates?
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
What does the pure expectations theory ignore?
future rates are uncertain
What are the two risk associated with bond investment?
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)
What are the interpretations of the pure expectations theory?
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
What is the liquidity theory?
yield curves will be upward sloping to reflect an increasing liquidity premium as a result of longer and longer maturities
What is the preferred habitat theory?
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)
What is market segmentation theory?
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