Final_FIN2700_Tomtam.pdf - Chapter 6 The Term Structure...

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Chapter 6 The Term Structure & Risk Structure of Interest Rates The term structure of interest rates is the relationship at any given times between the length of time to maturity and the yield on a debt security. The yield curvegraphically depicts the term structure of interest rates. The shape of yield curve: 1. Flat yield curve 2. Ascending (Upward sloping) yield curve 3. Descending (Downward sloping, inverted) yield curve 4. Humped yield curve
4 Theories of Term Structure: 1. Pure Expectations Theory
2. Liquidity Premium Theory
4. Preferred Habitat TheoryThis hybrid theory combines elements of the other three. Borrower & lenders do hold strong preferences for particular maturities. The yield curve will not conform strictly to the predictions of the other three theories. The Risk Structure of Interest Rates A security issuer defaults if it fails to meet the terms of the contractual agreement in full. Embedded in the yield of risky securities is a premium to compensate lenders for default risk. Risk Premium: additional yield contained in financial instruments to compensate lenders for default risk.
Chapter 8 The Foreign Exchange Market The foreign exchange marketis the market in which parties exchange national currencies. It is not a public outcry auction market, but rather operates as a computer driven over-the-counter market. The volume of activity has escalated dramatically in response to the growth in world trade volume in goods & services. International capital flows: The acquisition of financial & real assets across national borders 90% of foreign exchange volume is associated with capital flows. Participants in Foreign Exchange MarketThe direct or immediate participants (Dealers)-commercial banks with international deposits & foreign branches. The ultimate participants: import & export firms, tourists & other travelers, & financial entities seeking to invest internationally.

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