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Chapter 06a - CHAPTER6 InterestRates curves...

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    6-1 CHAPTER 6 Interest Rates Determinants of interest rates The term structure and yield  curves Investing overseas
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    6-2 What four factors affect the level  of interest rates? Production  opportunities Time preferences for  consumption Risk Expected inflation
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    6-3 “Nominal” vs. “Real” rates r = represents any nominal rate r* = represents the “real” risk-free rate  of interest.  Like a T-bill rate, if there  was no inflation.  Typically ranges  from 1% to 4% per year. r RF = represents the rate of interest on  Treasury securities.
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    6-4 Determinants of interest rates r = r* + IP + DRP + LP + MRP r   = required return on a debt security r* = real risk-free rate of interest IP = inflation premium DRP= default risk premium LP = liquidity premium MRP= maturity risk premium
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    6-5 Premiums added to r* for  different types of debt IP MR P DR P LP S-T Treasury L-T Treasury S-T Corporate L-T Corporate
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    6-6 Yield curve and the term  structure of interest rates Term structure –  relationship between  interest rates (or  yields) and maturities. The yield curve is a  graph of the term  structure. The November 2005  Treasury yield curve  is shown at the right. 0 1 2 3 4 5 6 0.25 0.5 2 5 10 30 Maturity (years) Yield  (% )
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    6-7 Constructing the yield curve:  Inflation Step 1 – Find the average expected inflation  rate over years 1 to N: N INFL IP N 1 t t N = =
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