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Chapter 6 - The structure of interest rates. After studying this chapter you will be able to: Describe and explain the relationship between interest rates and the term-to-maturity of a financial instrument, explain the meaning and the measurement of default risk premiums, describe how tax treatment affects yield differences across different types of securities,. | Power Point Slides for: Financial Institutions, Markets, and Money, 9th Edition Authors: Kidwell, Blackwell, Whidbee & Peterson Prepared by: Babu G. Baradwaj, Towson University And Lanny R. Martindale, Texas A&M University CHAPTER 6 THE STRUCTURE OF INTEREST RATES Factors that Influence Interest Rate Differences Term to Maturity. Default Risk. Tax Treatment. Marketability. Term (Maturity) Structure May be studied visually by plotting a yield curve at a point in time A yield curve is a smooth line, which shows the relationship between maturity and a security's yield at a point in time. The yield curve may be ascending (normal), flat, or descending (inverted). Several theories explain the shape of the yield curve. Yield Curves in the 2000s - Exhibit 6.1 Yield Curves and the Business Cycle Interest rates are directly related to the level of economic activity. An ascending yield curve notes the market expectations of economic expansion and/or inflation. A descending yield | Power Point Slides for: Financial Institutions, Markets, and Money, 9th Edition Authors: Kidwell, Blackwell, Whidbee & Peterson Prepared by: Babu G. Baradwaj, Towson University And Lanny R. Martindale, Texas A&M University CHAPTER 6 THE STRUCTURE OF INTEREST RATES Factors that Influence Interest Rate Differences Term to Maturity. Default Risk. Tax Treatment. Marketability. Term (Maturity) Structure May be studied visually by plotting a yield curve at a point in time A yield curve is a smooth line, which shows the relationship between maturity and a security's yield at a point in time. The yield curve may be ascending (normal), flat, or descending (inverted). Several theories explain the shape of the yield curve. Yield Curves in the 2000s - Exhibit 6.1 Yield Curves and the Business Cycle Interest rates are directly related to the level of economic activity. An ascending yield curve notes the market expectations of economic expansion and/or inflation. A descending yield curve forecasts lower rates possibly related to slower economic growth or lower inflation rates. Security markets respond to updated new information and expectations and reflect their reactions in security prices and yields. Yield-Curve Patterns Over the Business Cycle Uses of the Yield Curve At any point in time, the slope of the yield curve can be used to assess the general expectations of borrowers and lenders about future interest rates! Investors can use the yield curve to identify under-priced securities for their portfolios. Issuers may use the yield curve to price their securities. Investors use the yield curve for a strategy known as riding the yield curve. Default Risk It is the probability of the borrower not honoring the security contract Losses may range from “interest a few days late” to a complete loss of principal. Risk averse investors want adequate compensation for expected default losses. Default Risk, cont. Investors charge a default risk premium .
