Class 12 "and 15" Completed

K the bank of canada determines very short term

Info icon This preview shows pages 11–14. Sign up to view the full content.

View Full Document Right Arrow Icon
K The Bank of Canada determines very short term interest rates through its influence on the overnight rate This is the rate at which banks can borrow cash reserves on an overnight basis . K All other interest rates are determined by market forces. Where supply of lending matches demand for borrowing. K Term Structure of Interest Rates: Different markets for different terms to maturity. » Yield curve. » Zero-coupon government bond yield curve K Different markets for different risk types. Government vs. corporate bonds 11
Image of page 11

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
12 The Term Structure of Interest Rates and the Yield Curve K When we calculated the present value of an annuity using the PV Annuity Formula, we assumed that we could apply the same interest rate to all future annuity payments, whether they were one year from now or 30 years from now. K When you look at interest rates that banks offer on financial investments or charge for loans, you will notice that they depend on the horizon (or term ) of the investment or loan. For example, the yield-to-maturity for a 1-year zero-coupon Government Bond is different from the yield-to-maturity for a 30-year zero-coupon Government Bond. K Think about the risk of a 30-year bond compared to a 1-year bond. K The relationship between the investment term (time to maturity) and the interest rate on zero-coupon Government bonds is called the Term Structure of Interest Rates . K The graphical representation of the term structure is called the Yield Curve .
Image of page 12
13 How to Dismantle a Yield Curve K What accounts for the fact that the shape of the yield curve changes all the time? K For a zero-coupon government bond yield curve, there are three components: The real interest rate K The return investors require to save or invest their money instead of consuming it. Often assumed to be constant for all maturities. K Can change over time, though. This would effect the level of interest rates but not the slope of the yield curve. An interest rate risk premium K Always increasing with time to maturity. K That is because longer-term bonds are always riskier than shorter- term bonds. An inflation premium K The inflation premium can increase or decrease with time to maturity. If investors believe that inflation will be higher in the future, the yield curve slopes upwards.
Image of page 13

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 14
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern