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20 download_doc-7.php - BUS-G 345 Lecture/2011 Term...

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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. Explains facts 1 & 2, not 3 b. Segmented markets theory i. Explains fact 3, not 1 or 2
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BUS-G 345 Lecture # c. Liquidity premium theory i. Combines the 2 theories to explain facts 1, 2, & 3 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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