| inverted yield curve | rates on short term maturities are higher than those of long term maturities, this curve is rare and indicative of recession |
| upward sloping yield curve | interest rates on short term maturities are lower than rates on long term maturities |
| humped yield curve | interest rates on medium-term maturities are higher than rates on short and long term maturities |
| pure expectations theory | 1) focus on Treasury bonds and (2) assume that Treasury bonds contain no maturity risk premiums. |
| will the yield curve of highly liquid assets or relatively liquid assets be higher? | relatively liquid assets will be higher (b/c higher risk) |
| what will be higher? the default risk on Walmart’s short term or long term debt? | default risk on long term |
| what happens to the yield curve when inflation is expected to decrease? | the curve is downward sloping |
| if the pure expectations theory is correct, what is an upward sloping yield curve indicative of? | future short term rates are expected to be higher than current short term rates |
| why does long term debt have a higher default risk? | longer exposure to the possibility of default leads to a higher default risk premium |
| Macroeconomic Factors That Influence Interest Rate Levels | (1) Federal Reserve policy; (2) the federal budget deficit or surplus; (3) international factors, including the foreign trade balance and interest rates in other countries; and (4) the level of business activity. |
| So the larger the federal deficit, other things held constant, the (higher/lower) the level of interest rates | higher |
| when the economy is weakening, the fed is likely to (increase/decrease) short-term interest rates | increase |
| during recessions, short-term interest rates decline (more/less) sharply than long term interest rates | more |
| what does the federal reserve board have significant influence over? | level of economic activity, inflation, and interest rates |
| If the nominal rate is is 6% and interest is compounded quarterly, what is the periodic and effective rate? | periodic is 1.5% (6/4) and effective rate is greater than 6 |
| which of the following bank accounts has the lowest effective annual return? | 7% nominal interest with monthly compounding. this is less than 8% interest with yearly compounding |
| will the nominal rate exceed the effective rate? | no |
| what do present value calculations do? | discount all future cash flows back to the present |
| other things remaining equal, the PRICE today and GROWTH RATE are inversely related (True or False) | True |
| never ending stream of equal periodic, end of the period, cash flows is called a/an | perpetuity |
| forms of perpetuities | British consol bond, preferred stock that pays the same dividend forever, a philanthropic endowment fund that pays the same charitable amount every year forever |
| the phrase “price to rent money” is sometimes used to refer to what? | interest rate |
| four determinants of of the level of interest rates | 1) production opportunities: investment in cash generating assets 2) time preferences for consumption: current consumption is preferred to savings 3) (Aversion to) Risk: higher risk=higher rate 4) expected inflation: increase in general price level over time decreases purchasing power |
| what happens to interest rates when inflation is high? | interest rates are high |
| which of the following would be most likely to lead to a higher level of interest rates in the economy? | corporations set up their expansion plans and increase their demand for capital |
| which of the following factors would be most likely to lead to an increase in nominal interest rates? | a new technology like the internet has just been introduced, and it INCREASES INVESTMENT OPPORTUNITIES |
| what would happen if the US Treasury issued $50 billion of short term securities to the public? what would be the effect on prices and interest rate? | the prices would drop, and the interest rate would increase |
| what financial security is used as the risk free rate? | treasury bills |
| assume that the interest rates on 20 year treasury and corporate bonds are as follows: $$$ the differences in these rates were probably caused by_______ | default and liquidity risk differences |
| the yield curve shows the relationship between ______ _______ and their ________ | bonds’ maturities; yields |
| If the treasury yield curve is downward sloping, how should the yield to maturity on a 10 year treasury coupon bond compare to that on a 1-year-T Bill? | the yield on a 10-year bond would be less than that on a 1-year bill |
| If the yield is inverted, the 20 year interest rate will be less than the 1 year (True/False) | True |
| Are corporate yields higher or lower than that of treasury securities? | higher |
| when does the spread between corporate and treasury yields widen? | when corporate bond rating decreases |
| major assumption of the pure expectations theory | maturity risk premium (MRP) for treasury securities is 0-long term rates are an average of current and future rates -if the pure expectations theory is correct you can use the yield curve to “back out” expected future interest rates |
| Assume that the current corporate bond yield curve is upward sloping, or normal. Under this condition, we could be sure that…. | maturity risk premiums could help explain the yield curve’s upward slope |
| If the pure expectations theory is correct, what is true of yield curve for corporate bonds? | it may be upward sloping even if the treasury yield curve is flat |
