ch3_structure of Interest Rates

ch3_structure of Interest Rates - Chapter3...

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Financial Markets and Institutions Chapter 3 Structure of Interest Rates
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Financial Markets and Institutions Characteristics of Debt Securities Credit (default) risk Securities with a higher degree of risk have  to offer higher yields  Credit risk is especially relevant for longer- term securities
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Financial Markets and Institutions Characteristics of Debt Securities (cont’d) Credit (default) risk (cont’d) Rating agencies Moody’s / Standard and Poor’s  investment-grade bonds  are  Baa or better by  Moody’s and BBB or better by Standard and  Poor’s
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Financial Markets and Institutions Characteristics of Debt Securities (cont’d) Credit (default) risk (cont’d) Shifts in credit risk premiums Accuracy of credit ratings
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Financial Markets and Institutions Characteristics of Debt Securities (cont’d) Liquidity Liquid  securities can be easily converted  to cash without a loss in value Securities with lower liquidity have to offer  a higher yield to be preferred
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Financial Markets and Institutions Characteristics of Debt Securities (cont’d) Tax status Investors are more concerned with after- tax income than before-tax income The after-tax yield is equal to: ) 1 ( T Y Y bt at - =
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Financial Markets and Institutions Characteristics of Debt Securities (cont’d) Tax status Computing the equivalent before-tax  yield ) 1 ( T Y Y at bt - =
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Financial Markets and Institutions Exhibit 3.2 After-Tax Yields Based on  Various Tax Rates and Before-Tax Yields
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Financial Markets and Institutions Computing the Equivalent Before-Tax  Yield   Assume a firm in the 30 percent tax bracket is  aware of a tax-exempt security that pays a  yield of 9 percent. To match this after-tax  yield, taxable securities )with similar maturity :and risk( must offer a before-tax yield of % 86 . 12 ) 3 . 1 ( % 9 ) 1 ( = - = - = T Y Y at bt
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Financial Markets and Institutions Characteristics of Debt Securities (cont’d) Term to Maturity The  term structure of interest rates  defines  the relationship between maturity and  annualized yield Special provisions call feature   convertibility clause  
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ch3_structure of Interest Rates - Chapter3...

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