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Lecture-Notes-Chap6-10

Lecture-Notes-Chap6-10 - Chapter 6 Interest Rates Interest...

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22 Chapter 6 -- Interest Rates Interest rates The determinants of interest rates Term structure of interest rates and yield curves What determines the shape of yield curves Other factors Interest rates Cost of borrowing money Factors that affect cost of money: Production opportunities Time preference for consumption Risk Inflation Demand and supply for funds, see Figure 6-1 The determinants of interest rates r = r* + IP + DRP + MRP + LP where r = the quoted, or nominal rate on a given security r* = real risk-free rate IP = inflation premium (the average of expected future inflation rates) DRP = default risk premium MRP = maturity risk premium LP = liquidity premium and r* + IP = r RF = nominal risk-free rate (T-bill rate) Examples Term structure of interest rates and yield curves Term structure of interest rates: the relationship between yields and maturities Yield curve: a graph showing the relationship between yields and maturities Normal yield curve (upward sloping) Abnormal yield curve (downward sloping) Humped yield curve (interest rates on medium-term maturities are higher than both short-term and long-term maturities)
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