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
Corporate Baa Bonds
Generally, which bond has the highest interest rate?
the chance the issuer will be unable to make interest payments or repay principal.
Default risk is:
the demand for A to decrease and the demand for B to increase.
Suppose that there are two bonds, A and B. Suppose also the default risk on bond A increases. As a result of this we would expect to see:
the difference in interest rate between that bond and a US government bond.
The risk premium on a bond is:
increase the risk premium on bond A and reduce the risk premium on bond B.
An increase in the level of risk for bond A will:
they are exempt from Federal taxes.
Municipal bonds generally have lower interest rates than U.S. Government bonds because:
the relationship between time to maturity and bond interest rates (yields).
Yield curves show:
the market expects the interest rate on a one year bond in one year to be 9%.
According to the expectations theory of the term structure, if the interest rate on a one year bond is 5% and the interest rate on a two year bond is 7%, then:
up-sloping.
The liquidity premium theory suggests that yield curves should usually be:
investors prefer short-term bonds.
The liquidity premium theory is based upon the idea that, other things remaining equal,
upward sloping.
The shape of the yield curve is usually:
buyers of bonds consider bonds of different maturities to be perfect substitutes.
The expectations theory of the term structure assumes:
It will steeply slope upward.
What will the yield curve look like if future short-term interest rates are expected to rise sharply?
Will increase when the risk of default rises.
The risk premium of a bond
Investors have strong preferences for bonds of a particular maturity.
The Segmented Markets theory of term structure suggests that
____________ bonds are generally considered to be default risk-free
Treasury
The more risk, demand goes _______
down
The lower risk, demand goes ______
up
Additional interest that must be earned in order to entice someone to hold a risky bond over a risk-free bond.
risk premium
The higher the potential of default, the higher the __________________
risk premium
Have low risk of default and have a rating of Baa(or BBB) or above
Investment-Grade Securities
Have a higher risk of default and are given a lower rating.
Speculative-Grade (Junk Bond) Securities
Banks can only hold __________ bonds
investment grade
How quickly an asset can be converted into a medium of exchange
Liquidity
T-Bond market is extremely ____
active
__________ bonds are the most liquid long-term bonds
Treasury
Municipal bonds are _____________ exempt
income tax
You must pay income tax on ____________ bonds
treasury and corporate
Municipal bonds have higher expected return so demand goes __________
up
Treasury bonds have lower expected return so Demand goes ___________
down
A plot of the yields on bonds with differing-terms to maturity but identical risk structure factors such as treasury securities
Yield Curve
Interest rates tend to ___________ over time
move together
Yield curves are more likely to have an upward slope when short-term rates are _____
low
Yield curves are more likely to have an downward slope when short-term rates are _____
high
Yield curves usually have a __________ slope
upward
Long-term yields are an average of
expected future short-term yields
Bonds of different maturities (are/are not) substitutes
are not
the interest rate at each maturity is determined
separately
For short-term bonds they have a:
higher demand, higher price, and lower yield than long term
Long term bonds have ________ interest rate risk
higher
Steep Upward-Slope of yield curve so expect _____ interest rates
higher
mild upward-slope of yield curve so expect _______ interest rates
stable
flat slope of yield curve so expect _______ interest rates
falling
Downward-Slope of yield curve (inverted) so expect ____________ interest rates
sharply falling
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