Meaning of Term Structure of Interest Rates
Significance of Term Structure of Interest Rates
What is Yield Curve?
A spot rate and a forward Rate
Theories of Term Structure of Interest Rates
Meaning of Term Structure of Interest Rates
Significance of Term Structure of Interest Rates
What is Yield Curve?
A spot rate and a forward Rate
Theories of Term Structure of Interest Rates
Government bonds are fixed interest securities
This means that a bond pays a fixed annual interest – this is known as the coupon
The coupon (paid in £s, $s, Euros etc.) is fixed but the yield on a bond will vary
The yield is effectively the interest rate on a bond
The yield will vary inversely with the market price of a bond
When bond prices are rising, the yield will fall
When bond prices are falling, the yield will rise
The Yield Curve is made up by graphing the plots of the yields of bonds of similar quality or risk class against their maturities, ranging from shortest to longest term.
In finance, the yield curve is the relation between the interest rate (or cost of borrowing) and the time to maturity of the debt for a given borrower in a given currency.
The most powerful tool for communication is our body. 90% of our communication is non-verbal. By being more focused on our body during conversations, negotiations or even in non-spoken occasions we can increase our level of impression and chance to take control of the situation. It's not a game but it is easy to adapt.
Government bonds are fixed interest securities
This means that a bond pays a fixed annual interest – this is known as the coupon
The coupon (paid in £s, $s, Euros etc.) is fixed but the yield on a bond will vary
The yield is effectively the interest rate on a bond
The yield will vary inversely with the market price of a bond
When bond prices are rising, the yield will fall
When bond prices are falling, the yield will rise
The Yield Curve is made up by graphing the plots of the yields of bonds of similar quality or risk class against their maturities, ranging from shortest to longest term.
In finance, the yield curve is the relation between the interest rate (or cost of borrowing) and the time to maturity of the debt for a given borrower in a given currency.
The most powerful tool for communication is our body. 90% of our communication is non-verbal. By being more focused on our body during conversations, negotiations or even in non-spoken occasions we can increase our level of impression and chance to take control of the situation. It's not a game but it is easy to adapt.
Saudi Arabia on the Move - An Aranca Special Report 2013Srinivas Macha
The Kingdom of Saudi Arabia (KSA), a completely oil-dependent economy until a few decades ago,
has now transformed into one of the most vibrant economies in the Middle East. Today, the country has
a diversified economic structure, strong international trade links, a stable political environment, strong
fiscal surplus and a vibrant financial services sector. Saudi Arabia’s increasing contribution to the global
economy has earned it a permanent seat at the G-20 -- the only OPEC member to get the honour. As the
exclusive knowledge partner for The Euromoney Saudi Arabia Conference 2013, Aranca has compiled
a special report on Saudi Arabia’s journey till 2025, highlighting the Kingdom’s economic potential,
its influence on the region’s economy and opportunities available. Given Saudi Arabia’s tremendous
potential as an attractive investment destination, we foresee opportunities in the financial sector as
the Kingdom looks to fund its growth plans. We also delve into the challenges around fully exploiting
demographic dividends, reducing reliance on public funding, attracting foreign investors, and reforming
capital markets and financial institutions
Ringling College of Art & Design: Content and Social MediaAutumn Sullivan
Had a wonderful conversation with students from Ringling College of Art & Design. What is, and what isn't, content, tips on strategy and creation, and how social media marketing works (and how it doesn't).
An overview of Greek philosophers that shaped the world by teaching us how to think.
Covers the teachings of Socrates, Plato, and Aristotle. Used in university philosophy class to creatively teach these men's ideas in a meaningful and impacting way.
Facebook is an online social networking service. Its name comes from a colloquialism for the directory given to students at some American universities.[5] Facebook was founded on February 4, 2004 by Mark Zuckerberg with his college roommates and fellow Harvard University students Eduardo Saverin, Andrew McCollum, Dustin Moskovitz and Chris Hughes.[6] The founders had initially limited the website's membership to Harvard students, but later expanded it to colleges in the Boston area, the Ivy League, and Stanford University. It gradually added support for students at various other universities before it opened to high-school students, and eventually to anyone aged 13 and over. Facebook now allows anyone who claims to be at least 13 years old to become a registered user of the website
Week- 5 Interest Rates and Stock MarketMoney and Banking Econ .docxalanfhall8953
Week- 5 Interest Rates and Stock Market
Money and Banking Econ 311
Thursday 7 - 9:45
Instructor: Thomas L. Thomas
Response over Time to an Increase in Money Supply Growth
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Risk Structure of Interest Rates
Bonds with the same maturity have different interest rates due to:
Default risk
Liquidity
Tax considerations
Long-Term Bond Yields, 1919–2011
Sources: Board of Governors of the Federal Reserve System, Banking and Monetary Statistics, 1941–1970; Federal Reserve; www.federalreserve.gov/releases/h15/data.htm.
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Risk Structure of Interest Rates (cont’d)
Default risk: probability that the issuer of the bond is unable or unwilling to make interest payments or pay off the face value
U.S. Treasury bonds are considered default free (government can raise taxes).
Risk premium: the spread between the interest rates on bonds with default risk and the interest rates on (same maturity) Treasury bonds
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Bond Ratings by Moody’s, Standard and Poor’s, and Fitch
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Risk Structure of Interest Rates (cont’d)
Liquidity: the relative ease with which an asset can be converted into cash
Cost of selling a bond
Number of buyers/sellers in a bond market
Income tax considerations
Interest payments on municipal bonds are exempt from federal income taxes.
Term Structure of Interest Rates
Bonds with identical risk, liquidity, and tax characteristics may have different interest rates because the time remaining to maturity is different
Yield curve: a plot of the yield on bonds with differing terms to maturity but the same risk, liquidity and tax considerations
Upward-sloping: long-term rates are above
short-term rates
Flat: short- and long-term rates are the same
Inverted: long-term rates are below short-term rates
Facts that the Theory of the Term Structure of Interest Rates Must Explain
Interest rates on bonds of different maturities move together over time
When short-term interest rates are low, yield curves are more likely to have an upward slope; when short-term rates are high, yield curves are more likely to slope downward and be inverted
Yield curves almost always slope upward
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Three Theories to Explain the Three Facts
Expectations theory explains the first two facts but not the third
Segmented markets theory explains fact three but not the first two
Liquidity premium theory combines the two theories to explain all three facts
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Expectations Theory
The interest rate on a long-term bond will equal an average of the short-term interest rates that people expect to occur over the life of the long-term bond
Buyers of bonds do not prefer bonds of one maturity over another; they will not hold
any quantity of a bond if its expected return
is less than that of another bond with a different maturity
Bond holders consider bonds with different maturities to be perfect substitutes
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Expectations Theory: Example
Let the c.
This article will describe about an overview of derivatives in Islamic Finance. Derivative is a "claim on a claim" the value of the derivative will depend on the value of the asset (stocks, bonds, etc) on which it has a claim.
2. 1. Pure Expectations Theory 1. Pure Expectations Theory
yield on a long-term bond equals the geometric mean (or Option 1: Invest in 1-year bond and roll-over
average) of the current short-term yield and successive 0 1 2 0i1 = 4%
future short-term yields. 1i2 = 8%
0i1 = 4% 1i2 = 8%
If transactions costs are zero, the investor would expect
to earn the same average return over the long run if they: Option 2: Invest in 2-year bond
1. purchase a short-term bond & "roll it over" every time 0 1 2 0i2 = 6%
it matures.
2. purchase a long-term bond & hold it to maturity
0i2 = 6%
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Pure Expectations Theory: Implications Pure Expectations Theory: Implications
If investors believe that short-term interest rates will If investors think interest rates will decline in the
be higher in the future, the yield curve today slopes future, the yield curve is downward.
upward.
Interest rate (%) Interest rate (%)
Maturity (Years) Maturity (Years)
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Pure Expectations Theory: Implications 2. Liquidity Premium Theory
In the pure expectations theory: The issue: long-term bonds entail greater market risk than
an ascending yield curve is evidence of market that short-term securities do.
interest rates are rising
a downward-sloping or inverted yield curve implies that
Market risk is the risk of fluctuation in the price of the
market expects that interest rates are falling
security due to interest rate changes.
a flat yield curve implies a consensus that future yields will
remain the same as current yields Investors may have to sell their assets prior to maturity,
In the pure expectations theory, nothing except the outlook exposing themselves to the possibility of losses as interest
for interest rates affects the shape of the yield curve. rates & thus market prices change.
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3. 2. Liquidity Premium Theory
If bond buyers are risk averse, they must be compensated
with a term premium for the greater market risk inherent in
long-term bonds.
tRL = tRL-1 + TP
The Liquidity Premium Theory states that the term
premium (TP) is positive & increases with the length of
term, so the normal yield structure is ascending (Upward
sloping).
Bond with longer maturity provides higher yield
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3. Segmented Markets Theory 3. Segmented Markets Theory
Interest rates depend on supply and demand in each market For Lenders (Supply):
Short term interest rates Long term interest rates Short term securities Long term securities provide
depend on depend on provide liquidity & stability stability of income (i.e. coupon
of principal (price bond)
1. Short-term supply for fund stability)
1. Long-term supply for fund
(Short-term lenders) (Long-term lenders) Lenders who prefer income
Lenders who prefer stability over principal stability
protection of principal will will prefer to invest in Long
2. Short-term demand for fund 2. Long-term demand for fund prefer to invest in Short
(Short-term borrowers) term securities (T-Bonds)
(Long-term borrowers) term securities (T-Bills)
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3. Segmented Markets Theory Segmented Markets Theory: Implications
For borrowers: Individuals & firms are strongly motivated to Yields in any maturity sector are determined strictly by supply
match the maturities of their assets with the maturities of & demand in that sector
their liabilities
Corporate & U.S. Treasury debt management decisions
Firms borrowing to finance Families buying homes prefer significantly influence the shape of the yield curve.
inventories prefer short- long-term fixed rate
If firms & the government are currently issuing
mortgages
term loans predominantly long-term debt the yield curve will be
relatively steep.
Municipalities & corporations
Banks need liquidity investing in long-term capital If they are issuing short-term debt short-term yields will
prefer to invest short-term projects borrow long-term be high relative to long-term yields.
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4. Segmented Markets Theory: Implications 4. Preferred Habitat Theory
Treasury debt management is a potential tool of economic This hybrid theory combines elements of the other three.
policy because it can influence the yield curve. Borrowers & lenders do hold strong preferences for particular
maturities.
Gov. wants to raise Short term yield & reduce Long term yield
The yield curve will not conform strictly to the predictions of
Gov. will issue only Short term debt
the other three theories.
higher demand
If expected additional returns to be gained by deviating
higher Short term yield from their preferred maturities become large enough,
Twisting the yield curve institutions will deviate from their preferred maturities.
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4. Preferred Habitat Theory The Risk Structure Of Interest Rates
Institutions will accept additional risk in return for A security issuer defaults if it fails to meet the terms of the
additional expected returns. contractual agreement (indenture) in full.
For a bond, default is either the borrower's failure to make full
Institutions change from their preferred maturities or
interest payments or to redeem at face value
habitats if expected additional returns from other
maturities are large enough. Embedded in the yields of risky securities is a premium to
Example (p. 133): banks shift to invest in L-T securities compensate lenders for default risk
if L-T securities provide large additional return (yield)
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Risk Premiums Risk Premiums
Moody's and Standard and Poor's, provide ratings of the
quality of bonds in the United States Risk premium = risky yield – risk free yield
(ranging from investment grade bonds to junk bonds)
Issuers (Borrowers) Credit Rating Interest rate Risk premiums increases during recessions & other
Government AAA 4% times when firms experience financial distress.
Good quality Company AA 6%
--- --- -- It decreased modestly during the economic boom.
--- --- --
Bad credit company D 10%
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