Chapter 5 -Finance

Term structure of interest rate

The mathematical relationship between the yields and the times to maturity on the debt securities of the same issuer as specified on the same date and denominated in the same currency.

Real interest rate

The name given to an interest rate that excludes the effect of expected future inflation.

Market segmentation theory

a theory used to explain the term structure of interest rates which states that every borrower and every lender has a preferred maturity and that the slope of the yield curve depends on the supply of and demand for funds in the short and long term markets.

Liquidity

an asset exhibiting less of this attribute can only be sold by: (1) waiting a long time, (2) discounting the price, and /or (3) incurring significant transaction costs.

Default risk

the chance that an investment will generate more than one possible return due to the potential for the investment's issuer failure to repay fully its interest or principal-repayment obligations or satisfy the other terms in the investment agreement

Interest rate risk

the chance that the return earned by a financial asset will increase or decrease due to a change in the value of an opportunity cost (market) interest rate.

Yield curve

the graphical representation of the term structure of interest rates for a specified issuer on a given day and currency.

yield

the percentage return generated by an investment, calculated as the cash flows received from the investment (for example, interest or dividend income and capital gains) divided by the purchase price of the investment.

Capital Gain

the profit that results from the appreciation in the value of an asset, calculated as the difference between a higher selling price and a lower purchase price.

Expectations theory

this theory of interest rates argues that the slope of the yield curve reflects the future inflationary expectations of investors, all else being equal.