Mishkin Money and Banking: CH 6

credit-rating agency

Investment advisory firms that rate the quality of corporate and municipal bonds in terms of the probability of default. 126

default

A situation in which the party issuing a debt instrument is unable to make interest payments or payoff the amount owed when the instrument matures. 30, 123

default-free bonds

Bonds with no default risk, such as U.S. government bonds. 124

expectations theory

The proposition that the interest rate on a long-term bond will equal the average of the short-term interest rates that people expect to occur over the life of the long-term bond. 132

inverted yield curve

A yield curve that is downward sloping. 130

junk bonds

Bonds with ratings below Baa (or BBB) that have a high default risk. 126

liquidity premium theory

The theory that the interest rate on a long-term bond will equal an average of short-term interest rates expected to occur over the life of the long-term bond plus a positive term (liquidity) premium. 136

preferred habit theory

A theory that is closely related to liquidity premium theory, in which the interest rate on a long-term bond equals an average of short-term interest rates expected to occur over the life of the long-term bond plus a positive term premium. 13 7

risk premium

The spread between the interest rate on bonds with default risk and the interest rate on default-free bonds. 124

risk structure of interest rates

The relationship among the interest rates on various bonds with the same term to maturity 123

segmented markets theory

A theory of term structure that sees markets for different-maturity bonds as completely separated and segmented such that the interest rate for bonds of a given maturity is determined solely by supply of and demand for bonds of that maturity 135

term structure of interest rates

The relationship among interest rates on bonds with different terms to maturity. 123

yield curve

A plot of the interest rates for particular types of bonds with different terms to maturity. 130