Chapter 05_How Do Risk and Term Structure Affect Interest Rate?

Chapter 5 How Do The Risk and Term Structure Affect Interest Rates

Chapter Preview ,[object Object],[object Object]

Chapter Preview ,[object Object]

Chapter Preview ,[object Object],[object Object],[object Object]

Risk Structure of Interest Rates ,[object Object],[object Object]

Risk Structure of Long Bonds in the U.S.

Risk Structure of Long Bonds in the U.S. ,[object Object],[object Object],[object Object]

Factors Affecting Risk Structure of Interest Rates ,[object Object],[object Object],[object Object],[object Object]

Default Risk Factor ,[object Object],[object Object]

Default Risk Factor (cont.) ,[object Object],[object Object]

Increase in Default Risk on Corporate Bonds

Analysis of Figure 5.2: Increase in Default on Corporate Bonds ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Default Risk Factor (cont.) ,[object Object],[object Object],[object Object]

Case: Enron and the Baa-Aaa spread ,[object Object],[object Object],[object Object]

Liquidity Factor ,[object Object],[object Object]

Decrease in Liquidity of Corporate Bonds Figure 5.2 Response to a Decrease in the Liquidity of Corporate Bonds

Analysis of Figure 5.1: Corporate Bond Becomes Less Liquid ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Liquidity Factor (cont.) ,[object Object]

Income Taxes Factor ,[object Object],[object Object],[object Object]

Income Taxes Factor ,[object Object],[object Object]

Tax Advantages of Municipal Bonds

Analysis of Figure 5.3: Tax Advantages of Municipal Bonds ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Case: Bush Tax Cut and Interest Rates ,[object Object],[object Object]

Term Structure of Interest Rates ,[object Object],[object Object]

The WSJ: Following the News ,[object Object],[object Object],[object Object]

Reading the Wall St. Journal Dynamic yield curve that can show the curve at any time in history http://stockcharts.com/charts/YieldCurve.html

Term Structure Facts to Be Explained ,[object Object],[object Object]

Interest Rates on Different Maturity Bonds Move Together

Term Structure Facts to Be Explained ,[object Object],[object Object],[object Object],[object Object]

Three Theories of Term Structure ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Expectations Theory ,[object Object],[object Object]

Expectations Theory ,[object Object],[object Object],[object Object]

Expectations Theory ,[object Object],Since ( i 2 t ) 2 is extremely small, expected return is approximately 2( i 2 t )

Expectations Theory ,[object Object],[object Object],Solving for i 2 t (1)

Expectations Theory ,[object Object]

More generally for n -period bond… ,[object Object],(2)

More generally for n -period bond… ,[object Object],[object Object],[object Object],[object Object],[object Object]

Expectations Theory and Term Structure Facts ,[object Object],[object Object],[object Object],[object Object]

Expectations Theory and Term Structure Facts ,[object Object],[object Object],[object Object]

Expectations Theory and Term Structure Facts ,[object Object],[object Object]

Market Segmentation Theory ,[object Object],[object Object]

Market Segmentation Theory ,[object Object],[object Object],[object Object]

Liquidity Premium Theory ,[object Object],[object Object]

Liquidity Premium Theory ,[object Object]

Liquidity Premium Theory ,[object Object],(3) ,[object Object]

Numerical Example ,[object Object],[object Object]

Numerical Example ,[object Object],[object Object],[object Object],[object Object]

Liquidity Premium Theory: Term Structure Facts ,[object Object],[object Object],[object Object]

Market Predictions of Future Short Rates

Evidence on the Term Structure ,[object Object],[object Object]

Case: Interpreting Yield Curves ,[object Object],[object Object]

Case: Interpreting Yield Curves, 1980–2008

Case: Interpreting Yield Curves ,[object Object]

Mini-case: The Yield Curve as a Forecasting Tool ,[object Object],[object Object],[object Object]

The Practicing Manager: Forecasting Interest Rates with the Term Structure ,[object Object],Solve for forward rate, i e t+1 (4) Numerical example: i 1t = 5%, i 2t = 5.5%

Forecasting Interest Rates with the Term Structure ,[object Object],Using i e t+1 derived in (4), solve for i e t+2

Forecasting Interest Rates with the Term Structure ,[object Object],Liquidity Premium Theory: i nt - = same as pure expectations theory; replace i nt by i nt - in (5) to get adjusted forward-rate forecast (5) (6)

Forecasting Interest Rates with the Term Structure ,[object Object],[object Object],[object Object],[object Object],Loan rate must be > 8.2%

Chapter Summary ,[object Object],[object Object]

Chapter 05_How Do Risk and Term Structure Affect Interest Rate?

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Chapter 05_How Do Risk and Term Structure Affect Interest Rate?