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Comm298-Week6-Term_structure_of_interest_rates-wit

# Comm298-Week6-Term_structure_of_interest_rates-wit - Com298...

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Com298: Week 6 Term Structure of Interest Rates Learning Objectives: Focus on the following: The Fisher effect. Meaning of term structure of interest rates. Yield to maturities and plotting the yield curves. Shapes of yield curves. Hypotheses of yield curves. The Fisher’s Effect The Fisher equation: The Fisher equation defines the relationship 1

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between nominal rates, real rates and the inflation rate. Nominal rate = real rate + expected inflation rate R = r + h where: R = nominal rate; r = real rate h = expected inflation rate Example: If investors require a 10% real return and the expected inflation is 8%, then investors will demand compensation for the loss in purchasing power. R = 10% + 8% = 18% The inflation premium will have to be 8% so that the nominal interest rate is 18%. Term Structure of Interest Rates The term structure of interest rates describes the relationship between long term rates and short term rates. 2
The term structure is important to two groups of market participants: Corporate treasurers deciding to borrow by issuing long term or short term debt. Investors who are deciding whether to buy long term or short term bonds. Sources of bond data: interest rates for bonds with different maturities can be found in a variety of sources, including: The Wall Street Journal The National Post The Globe and Mail Canadian Fixed Income.ca Bank of Canada.

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Comm298-Week6-Term_structure_of_interest_rates-wit - Com298...

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