Fin 330 Ch 9

Front 1

Board of Governors of the Federal Reserve System

Back 1

a board with seven governors, including the chairman, that plays an essential role in decision making within the Federal Reserve System

Front 2

Federal Open Market Committee (FOMC)

Back 2

committee that makes decisions regarding the conduct of open market operations

Front 3

federal reserve banks

Back 3

the twelve district banks in the Federal Reserve system

Front 4

instrument independence

Back 4

ability of the central bank to set monetary policy instruments

Front 5

goal independence

Back 5

ability of the central bank to set the goals of monetary policy

Front 6

open market operations

Back 6

the buying and selling of government securities in the open market. affects interest rates and the amount of reserves in the banking system

Front 7

political business cycle

Back 7

a cycle caused by expansionary policies before an election

Front 8

prime rate

Back 8

the basic interest rate on short-term loans that the largest commercial banks charge to their most creditworthy corporate customers

Front 9

bellwether rate

Back 9

interest rate that serves as a leader or as a leading indicator of future trends. ie; inflation

Front 10

federal funds rate

Back 10

interest rate that banks charge each other for overnight loans of $1 million or more

Front 11

discount rate

Back 11

the interest rate that the fed offers to commercial banks for overnight reserve loans

Front 12

call money rate

Back 12

the interest rate brokerage firms pay for call money loans from banks. basis for customer rates on margin loans

Front 13

commercial paper

Back 13

short-term, unsecured debt issued by the largest corporations

Front 14

Certificate of deposit (CD)

Back 14

large-denomination deposits of $100,000 or more at commercial banks for a specified term

Front 15

banker's acceptance

Back 15

a postdated check on which a bank has guaranteed payment. Commonly used to finance international trade transactions

Front 16

Eurodollars

Back 16

U.S. dollar denominated deposits in banks outside the US

Front 17

London Interbank Offered Rate (LIBOR)

Back 17

interest rate that international banks charge one another for overnight Eurodollar loans

Front 18

US Treasury Bill (tbill)

Back 18

a short-term US government debt instrument issued by the US Treasury

Front 19

Pure Discount Security

Back 19

interest-bearing asset that makes a single payment of face value at maturity. it makes NO payments before maturity

Front 20

Bank Discount Basis

Back 20

method of quoting interest rates on money market instruments. (we use 360 days in a year in this formula) Commonly used for t-bills and banker's acceptances

CurrentPrice = FV * (1- (Days to Maturity / 360) * Discount Yield)

Front 21

Bond Equivalent Yields (BEY)

Back 21

another way to quote an interest rate. convert a bank discount yield to this using this formula:

= (365 * Discount Yield) / (360 - Days to Maturity * Discount Yield)

Front 22

simple interest basic

Back 22

another method to quote interest rates. Used for CDs. calculated just like APRs

Front 23

Effective Annual Rate/effective yields/annualized yields (EAR)

Back 23

the true interest rate. An APR understates this. a way to convert APR to EAR is as follows:

1 + EAR = (1 - (APR) / (m)) ^ m where m=# of periods in a year

Front 24

fixed income securities

Back 24

long-term debt contracts from a wide variety of issuers: US gov, real estate purchases, corporations, muni govs. Maturity greater than one year

Front 25

Treasury yield curve

Back 25

plot of treasury yields against maturities; fundamental to bond market analysis and represents the interest rates for default-free lending across the maturity spectrum

Front 26

term structure of interest rates/zero-coupon yield curve

Back 26

relationship between time to maturity and the interest rates for default-free, pure discount instruments

Front 27

STRIPS

Back 27

pure discount instruments created by "stripping" the coupons and principal payments of US Treasury notes and bonds into separate parts, which are then sold separately. Calculated by:

Price = [ FV / ((1 + YTM/2) ^ 2M) ] M =# years to maturity

Front 28

Present Value

Back 28

FV / ( (1 + r)^N)

Front 29

Nominal interest rates

Back 29

interest rates as they are observed and quoted, with no adjustment for inflation

Front 30

real interest rates

Back 30

interest rates adjusted for inflation effects

interest rates = nominal interest rate - inflation rate

Front 31

Fisher Hypothesis

Back 31

asserts that the general level of nominal interest rates follows the general level of inflation. states that interest rates are, on average, higher than the rate of inflation

Front 32

expectations theory

Back 32

term structure of interest rates reflects financial market beliefs about future interest rates.

Problems: the term structure is almost always upward sloping. often the case that the term structure turns down at very long maturities

Front 33

market segmentation theory

Back 33

debt markets are segmented by maturity, so interest rates for various maturities are determined separately in each segment

problem: US gov borrows at all maturities

Front 34

maturity preference theory

Back 34

long-term interest rates contain a maturity premium necessary to induce lenders into making longer term loans

Problems: US gov borrows much more heavily short-term than long-term. many of the biggest buyers of fixed income securities, such as pension funds, have a strong preference for long maturities

Front 35

interest rate risk

Back 35

long-term bond prices are much more sensitive to interest rate changes than short-term bonds

Front 36

Modern term structure theory

Back 36

Nominal Interest Rate = Real Int. Rate + Inflation Premium + Interest Rate Risk Premium + Liquidity Premium (if not in liquid market) + Default Premium (if not in liquid market)