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Unformatted text preview: [Notes on Mishkin Ch.6 & Term Structure - P.1] Mishkin ch.6: Term Structure Concept of the Yield Curve. Online source : http://www.bloomberg.com/markets/rates/index.html Three theories: 1. Expectations hypothesis 2. Segmented markets theory 3. Liquidity premium theory ; also called Preferred Habitat theory. - With different assumptions about risk and return - Focus on the liquidity premium theory (others for illustration) Key questions: - for theory: How do investors trade-off risk against expected return?- for practice: What do investors expect about future interest rates? Remember: - Bond returns depend on future interest rates - Bond market = efficient market : Investors form rational expectations Application: Interpreting the yield curve = Extracting information about future interest rates [Notes on Mishkin Ch.6 & Term Structure - P.2] The Main Term-Structure Equation i nt = 1 n ! [ i t + i t + 1 e + ... + i t + n " 1 e ] + l nt i nt = yield on n-year bonds; i t = yield on 1-year bonds i t+i e = expected yield on 1-year bonds in year t+i l nt = liquidity premium on n-year bonds...
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- Fall '08