FNAN 405 FINAL: Chapter 9

"Simple" interest basis

-Another method to quote interest rates. -Calculated just like annual percentage rates (APRs). -Used for CDs. -The bond equivalent yield on a T-bill with less than six months to maturity is also an APR.

Problems with Market Segmentation Theory

-The U.S. government borrows at all maturities. -Many institutional investors, such as mutual funds, are more than willing to move maturities to obtain more favorable rates. -There are bond trading operations that exist just to exploit perceived premiums, even very small ones.

Problems with Maturity Preference Theory

-The U.S. government borrows much more heavily short-term than long-term. -Many of the biggest buyers of fixed-income securities, such as pension funds, have a strong preference for long maturities.

Problems with Expectations Theory

-The term structure is almost always upward sloping, but interest rates have not always risen. -It is often the case that the term structure turns down at very long maturities.

Banker's acceptance

A postdated check on which a bank has guaranteed payment. Commonly used to finance international trade transactions.

U.S. Treasury bill (T-bill)

A short-term U.S. government debt instrument issued by the U.S. Treasury.

effective annual rate (EAR).

An APR understates the true interest rate, which is usually called the

Market Segmentation Theory

Debt markets are segmented by maturity, so interest rates for various maturities are determined separately in each segment.

The U.S. government, Real estate purchases (mortgage debt), Corporations, and Municipal governments

Fixed-income securities include long-term debt contracts from a wide variety of issuers:

Federal funds rate

Interest rate that banks charge each other banks for overnight loans of $1 million or more.

London Interbank Offered Rate (LIBOR)

Interest rate that international banks charge one another for overnight Eurodollar loans.

interest rate risk

Long-term bond prices are much more sensitive to interest rate changes than short-term bonds. This is called:

Maturity Preference Theory

Long-term interest rates contain a maturity premium necessary to induce lenders into making longer term loans.

Commercial paper

Short-term, unsecured debt issued by the largest corporations.

Prime rate

The basic interest rate on short-term loans that the largest commercial banks charge to their most creditworthy corporate customers.

Call money rate

The interest rate brokerage firms pay for call money loans from banks. This rate is used as the basis for customer rates on margin loans.

CDs

The interest rate on certificates of deposit, which are large-denomination deposits of $100,000 or more at commercial banks

Discount rate

The interest rate that the Fed offers to commercial banks for overnight reserve loans.

Expectations Theory

The term structure of interest rates reflects financial market beliefs about future interest rates.

Bank Discount Basis Bond Equivalent Yields (BEY) Annual Percentage Rates (APR) Effective Annual Rates (EAR)

There are several different ways market participants quote interest rates.

Eurodollars

U.S. dollar denominated deposits in banks outside the United States.

Real interest rates

are adjusted for inflation effects

Nominal interest rates

are interest rates as they are observed and quoted, with no adjustment for inflation

STRIPS (Separate Trading of Registered Interest and Principal of Securities)

are pure discount instruments created by "stripping" the coupons and principal payments of U.S. Treasury notes and bonds into separate parts,which are then sold separately.

Fisher Hypothesis

asserts that the general level of nominal interest rates follows the general level of inflation. According to the _______, interest rates are, on average, higher than the rate of inflation

Bank Discount Basis

is a method of quoting interest rates on money market instruments. It is commonly used for T-bills and banker's acceptances.

HIBOR

is an interest rate based on Hong Kong dollars. Hibor is the interest rate among banks in the Hong Kong interbank market.

EURIBOR

is an interest rate that also refers to deposits denominated in euros. However, EURIBOR is based largely on interest rates from the interbank market for banks in the European Union.

Pure Discount Security

is an interest-bearing asset: -It makes a single payment of face value at maturity. -It makes no payments before maturity.

term structure of interest rates

is the relationship between time to maturity and the interest rates for default-free, pure discount instruments.

Real interest rate

nominal interest rate - inflation rate =

Euro LIBOR

refers to deposits denominated in euros—the common currency of 16 European Union countries.