Test 2 Study Guide

Test 2 Study Guide - Test2StudyGuide ExamTwo Wednesday10/13...

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Test 2 Study Guide 22:37 Exam Two Wednesday 10/13 Chapters 6,17,3 CHECK ELEARNING PRACTICE PROBLEMS Bring: 1. big grey scantron 2. #2 pencil 3. ID 4. Calculator expectations theory, future, avg rate 40 questions 6 :  17  questions (default risk, liquidity characteristics, risk structures interest  rates, other structure rates) 17:  15  questions (exchange rate, general stuff, dollar appreciation, exports  imports who gets affected, long run purchasing power parity, table that affect  exchange rates long run, and short run exchange rate ) 3: 8 (class notes)
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Chapter 6 22:37 The Risk and Term Structure of Interest Rates
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Chapter 6 22:37 Risk Structure of Interest Rates Risk structure of interest rates : the relationship among yields on financial  instruments that have the same maturity. Why do bonds with the same maturity have different yields? Default risk considerations Liquidity considerations Tax considerations Default risk The chance that an individual or a firm that issues a financial instrument may  be unable to honor its obligations to repay the principal and/or to make  interest payments. Default risk premium on Bond A = yield on bond A – yield on a risk-free bond of comparable maturity. Ex 1 a bond with default risk will always have a positive risk premium, and an  increase in default risk will increase the risk premium. Credit ratings default risk. Two broad risk categories:
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22:37 o Investment-grade securities: bonds with relatively low default risk. o Junk bonds: bonds with relatively high default risk. Liquidity Other things equal, a bond that is less liquid will have a higher yield. Taxation Ex 2 Other things equal, the yield on tax-free bonds will be less than the yield on  taxable bonds. Differences in degrees of default risk and liquidity result in risk premiums that  must be present in the yields on financial instruments. Risk premiums differ  across instruments, which is one key reason that yields differ. The different rates  at which some instruments are taxed also cause their yields to diverge. Risk Structure default risk liquidity tax Term structure of interest rates Explains why otherwise similar bonds with different maturities have different  yields. Ex 3
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This note was uploaded on 04/14/2011 for the course ECON 311 taught by Professor Edwardson during the Spring '08 term at Texas A&M.

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Test 2 Study Guide - Test2StudyGuide ExamTwo Wednesday10/13...

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