340 exam2

Topics: Bond, Investment, Stock market Pages: 4 (1734 words) Published: November 1, 2014

Four factors affect interest rate level: production opportunities, time preferences for consumption, risk and expected inflation Different Consumption preferences: borrow or lend to achieve the individual consumption desired “Real” rates r* represents the “real” risk-free rate of interest. Like a T-bill rate, if there was no inflation. From 1% to 4% per year. rRF = rate of interest on Treasury securities. (no risk of default); rRF =r* + IP= avg. inflation rate expected over life of security & compensate expected loss of purchasing power. r = r* + IP + DRP + LP + MRP (inflation premium, default risk premium, liquidity premium, maturity risk premium) IP MRP DRP LP

ST Treasury X LT Treasury X X ST Corporate X X X
LT Corporate X X X X
Upward slope due to ↑ expected inflation and ↑maturity risk premium. Corporate yield curves are higher than that of Treasury securities, though not necessarily parallel to the Treasury curve. The spread between corporate and Treasury yield curves widens as the corporate bond rating decreases. Interest rates: BB>AAA>treasury Yield Curve

Other factors that influence interest rate: Fed. Reserve policy, Fed. Budget surplus or deficit, level of business activity, International factors CHAPTER 7:
Types: Treasury-government bonds-no default risk, Agency - quasi government, corporate bonds, Municipal bonds, foreign bonds Bond Markets primarily traded in the over-the-counter (OTC) market. Most bonds are owned by and traded among large financial institutions. WSJ: key developments in the Treasury, corp. and municipal markets. The discout rate (Ki) is the opportunity cost of capital, and is the rate that could be earned on alternative investments of equal risk. if coupon rate > YTM, bond’s value > par value - sold at premium Current yield (CY) = annual coupon payment/current price

Capital gains yield (CGY) = change in price/beginning price
Expected total return = YTM = Expected CY + Expected CGY
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