CHAPTER 6
Review Questions:
6-2 What is the term structure of interest rates, and how is it related to the yield curve?
Term structure interest rate is a rate which relates the interest rate or rate of return to the time to maturity.
The yield curve is a graph of relationship between the debt’s remaining time to maturity and its yield to maturity. Term structure of interest rate can be shown graphically by yield curve. The shape of the yield curve will show the useful ways to future interest rate expectation.
6-3 For a given class of similar-risk securities, what does each of the following yield curves reflect about interest rates: (a) downward-slopping; (b) upward-slopping; and (c) flat? Which form has been historical dominant?
For a given class of similar-risk securities, A downward yield curve shows cheaper long-term borrowing lists than the short-term borrowing lists (inverted yield curve). Upward yield curves represent cheaper short-term borrowing lists than the long-term borrowing lists (normal yield curve). The flat one shows similar borrowing costs for both short-term and long-term loans.
6-4 Briefly describe the following theories of general shape of the yield curve: (a) expectation theory; (b) liquidity preference theory; and (c) market segmentation theory. Expectation theory implies that the yield curve reflects investors’ expectation about the future interest rate and inflation. Higher the future inflation rate, higher the long-term
In standard economics, the rate of interest is determined by the market for loanable funds, funds available for borrowing. The supply of loanable funds comes from savings and from money creation. Savings is defined as income minus spending for consumption. Time preference is a general tendency rather than a universal absolute; hence, some people with a strong concern for their future would save funds even at an interest rate of zero. With a higher rate of interest, more people are willing to save funds, so at some quantity of saved funds, the supply curve of savings rises with higher rates of real
The Yield to Maturity (YTM) of a bond is: Interest rate that makes the present value of the bond’s
Answer: The Coupon Rate is a generally fixed and is known as the stated rate of a bond that determines the periodic interest payments. As stated in the textbook, the annual coupon dividen by the face value is called the coupon rate of the bond. The YTM rate of return anticipated on the bond if it is held until the maturity Date. YTM is considered a long-term bond yield expressed as an annual rate.
Coupon rate is fixed and determines what the bonds coupon will be. The required return is what investor actually demands on the issue and it will fluctuate through time.
The interest rate, or more precisely, the "federal funds rate," is the cost at which banks borrow money from the Federal
b. Generate a graph or table showing how the bond’s present value changes for semi-annually compounded interest rates between 1% and 15%.
We know that the term structure of interest rates describes the relationship between short and long term interest rates. What is important to understand when reading this article is to remember that the yield curve does not always have to be upward sloping. The rates on long term securities are only above short term rates if the yield curve is upward sloping or "normal." This is not always the case; depending on the expectations of the market the yield curve can also be "abnormal" or inverted if short term rates are expected to be higher than that of long term interest rates. It is also possible to have a humped yield curve if interest rates on medium securities are expected to be higher than both short and long term securities.
Keynes’ Liquidity Preference Framework: determines interest rate in terms of supply and demand for money
The interest rate (APR) rate is the amount of extra money you have to pay back for your loan. When you apply for a loan, you will see an interest
It’s necessary to determine the yield to maturity and coupon rate because the the discount rate for a coupon bond is its yield to maturity, which equates the present value of the future cash flows of bond relative to its price. Generally, a bond trade at a discount because its coupon rate comparatively lesser than as compared to it yield to maturity. It trade at a premium because its coupon rate increases its yield to maturity. A bond trade at par because coupon rate equals its yield to maturity (J. Van Horne &, John M Wachowicz, 2008).
The yield curve is a graph that plots the yields of similar-quality bonds against their maturities, ranging from shortest to longest. The relationship between yield and maturity is referred to as the term structure of interest rates. The Treasury yield curve is the base or benchmark for pricing bonds and setting yields in other areas of the debt market. Moreover, the shape of the yield curve is constructed from U.S Treasury strips which are zero-coupon
The validation procedure of the aforementioned five theories and their relationship begins with the description of ‘Interest rate’. Interest rate is the amount charged by a lender from the borrower for the use of assets such as cash or goods and is represented in the form of percentage typically noted on an annual basis. There are two types of Interest: Simple Interest and Compound Interest. Values of both can be calculated by the formulae written below:
17:3%. Later, A.-S. Chen, Leung, and Daouk (2003) predicted the direction of the return on the
The IS curve shows various combinations of interest rates and levels of income at which the goods markets clear while the LM curve shows that the demand for money depends on the interest rate and income and there are various combination of interest rates and income levels, at which the money market
Describe the differences in interest payments and bond price between a 5 percent coupon bond and a zero coupon bond.