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BUS-G 345
Lecture #
#/##/2011
Term Structure of Interest Rates
I.
Term Structure of interest rate
a.
Bonds with identical risk, liquidity, and tax characteristics may have different
interest rates because the time remaining to maturity is different
II. Yield curve
a.
Definition
i.
A graph of US treasury debt instruments as a function of maturity
b.
Shapes and their meaning
i.
Upward sloping
1.
Long-term rates are above short-term rates
ii. Flat
1.
Short and long term rates are the same
iii. Inverted
1.
Long-term rates are below short-term rates
III. Facts that the theory of the term structure of interest rates must explain
a.
Interest rates on bonds of different maturities move together over time
b.
When short-term interest rates are low, yield curves are more likely to have an
upward slope; when short-term rates are high, yield curves are more likely to
slope downward and be inverted
c.
Yield curves almost always slope upward
IV.Three theories to explain the three facts
a.
Expectations theory
i.
b.
Segmented markets theory
i.
Explains fact 3, not 1 or 2

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*Sign up*BUS-G 345
Lecture #
c.
Liquidity premium theory
i.
V. Expectations theory
a.
The interest rate on a long-term bond will equal an average of the short-term
interest rates that people expect to occur over the life of the long-term bond
b.
Buyers of bonds do not prefer bonds of one maturity over another; they will

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