ch 06 - Chapter 6 Interest Rates Cost of Money and Interest...

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Interest Rates Chapter 6 Cost of Money and Interest Rate  Levels Determinants of Interest Rates The Term Structure and Yield  Curves Using Yield Curve to Estimate Future  Interest Rates 6-1
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What four factors affect the level of interest  rates? Production  opportunities Time preferences  for consumption Risk Expected inflation 6-2
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“Nominal” vs. “Real” Rates 6-3 r = represents any nominal rate r* = represents the “real” risk-free rate  of interest.  Like a T-bill rate, if there was  no inflation.  Typically ranges from 1% to  5% per year. r RF = represents the rate of interest on  Treasury securities.
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Determinants of Interest Rates 6-4 r = r* + IP + DRP + LP + MRP r = required return on a debt security r* = real risk-free rate of interest IP = inflation premium DRP = default risk premium LP = liquidity premium MRP = maturity risk premium
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Premiums Added to r* for Different Types of  Debt 6-5 IP MRP DRP LP S-T Treasury L-T Treasury S-T Corporate L-T Corporate
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Yield Curve and the Term Structure of  Interest Rates 6-6 Term structure –  relationship between  interest rates (or yields)  and maturities. The yield curve is a  graph of the term  structure.
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