361-CH6Concise - 6-1CHAPTER 6 Interest RatesUpdated...

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Unformatted text preview: 6-1CHAPTER 6: Interest RatesUpdated: January 23, 2012Determinants of interest ratesThe term structure and yield curvesInvesting overseas6-2What 4 factors affect the cost of money (Interest Rates)?1. Production opportunities: Dc - Interest rates are pro-cyclical2. Time preferences for consumption - the higher value on current (future) consumption, the higher (lower) the interest rate3. Risk - higher (lower) risk, higher (lower) interest rate4. Expected inflation - higher expected inflation, higher interest rates6-3“Nominal” vs. “Real” ratesr= Represents any nominal rater*= Represents the “real” risk-free rate of interest. Like a T-bill rate, if there was no inflation. Typically ranges from 1% to 4% per year.rRF= Represents the rate of interest on default risk-free Treasury securities.6-4Determinants of interest ratesr = r* + IP + DRP + LP + MRPr = required return on a debt securityr*= real risk-free rate of interestIP= inflation premium (Пe)DRP= default risk premium (see p. 183)LP= liquidity premium (illiquidity)MRP= maturity risk premium (time)6-5Premiums added to r* for different types of debtIPMRPDRPLPS-T TreasuryL-T TreasuryS-T CorporateL-T Corporate6-6Yield curve and the term structure of interest ratesTerm structure – relationship between interest rates (or yields) and maturities.The yield curve is a graph of the term structure.The November 2005 Treasury yield curve is shown at the right.1234560 .2 5 0 .5 2 5 1 0 3 0M aturity ( years)Yield ( % )6-7Constructing the yield curve: InflationStep 1 – Find the average expected inflation rate over years 1 to N:NINFLIPN1ttN∑==6-8Constructing the yield curve:...
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361-CH6Concise - 6-1CHAPTER 6 Interest RatesUpdated...

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