BAFI
Topic 3 Interest rate risk - Nov2017.pptx

Topic 3 Interest rate risk - Nov2017.pptx - Risk Management...

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Risk Management BAFI 1029 Topic 3: Interest rate risk
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Important Note These lecture notes are prepared for an overall understanding of Topic 3. You are expected to thoroughly read the lecture notes after your Lecture. 2
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Interest rate instruments Key reasons for issuing or investing in such instruments A regular and known income stream; Higher returns generated compared to cash or deposit accounts; Assist in diversifying assets during volatile markets in order to reduce risk; Capital preservation; and Used as a hedging tool to minimize interest rate risk. 3/8/18 RMIT University©2015 3
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Shape of the yield curve 3/8/18RMIT University©2015 4 (a) Horizontal or flat yield curve, indicating interest rates will remain stable over time; (b) Upward sloping yield curve, reflecting expectations that interest rate are higher when invested for a longer period of time; (c) Downward sloping or inverse yield curve that displays higher short term rates indicating rates will decline over time; (d) Humped yield curve reflects temporary higher interest rates followed by gradual decline in interest rates.
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Shape of the yield curve What determines the shape of the yield curve? Liquidity preference theory Market segmentations theory Preferred habitat 3/8/18RMIT University©2015 5
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Sensitivity of interest rates Price of long term bonds are more sensitive to interest rate changes than short term bonds because there are more
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