4504ts - The Term Structure of Interest Rates - Term...

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The Term Structure of Interest Rates - Term structure of interest rates Relationship between time to maturity and yields for a particular category of bonds at a particular point in time Curve shifts and twists through time. Yield curves Graphical depiction of the relationship between yields and time for bonds that are identical except for maturity with default risk held constant, same tax treatment, same special features Two Components: Four Basic Shapes: Positive Yield Curve: upward sloping—typically interest rates rise with maturity Negative Yield Curve: downward sloping—unusual and is often a predictor of a recession Flat Yield Curve: Transition period from boom to recession Humped Yield Curve: Rise then falls o Level of the curve Loanable Funds Theory Liquidity Preference Theory Level of Interest Rates: Loanable Funds Theory -- market interest rate is determined by the factors that control the supply of and demand for loanable funds. Demand Factors Household: Income (y) increases then installment debt increases Rates drop then installment debt increases Business: Government: interest inelastic 1980: debt/GDP =25% 1987: debt/GDP=42% 1998: debt/GDP = Foreign Foreign interest rates vs. U.S. rates Supply (?) NPV decrease i if _
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Households - largest suppliers Very steep slope for supply. Why? What happens if expect higher inflation? Savers – Borrowers Liquidity Preference Theory - Market rate of interest is determined by demand/supply of money balances. o
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4504ts - The Term Structure of Interest Rates - Term...

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