FNAN 405: Ch. 9

Treasury Bill quotes, bid and ask discounts:

-Bid discount: price you will receive for T-bill; price dealers are willing to pay for a T-bill. -Ask discount: price you will pay for the T-bill; price dealers will accept to sell the T-bill.

Formula for converting APR to EAR:

1 + EAR = (1 + APR/m)^m where m=# of periods in a year and apr = interest rate per period * # of periods in a year

Bank discount basis

A method for quoting interest rates on money market instruments; interest rate quote for T-bills and banker's acceptances; called discount yield.

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 US government debt instrument missed by the U.S. Treasury.

A pure discount security is an interest-bearing asset that pays?

A single payment at maturity

Pure discount rate

An interest-bearing asset that makes a single payment of face value at maturity with no payments before maturity.

Real interest rates

Are adjusted for inflation effects; Real interest rate = nominal interest rate - inflation rate.

Nominal interest rates

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

STRIPS

Are pure discount instruments created by "stripping" the coupons and principal payments of US 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; states that interest rates are, on average, higher than the rate of inflation.

Formula for calculating T-bill ask price using BEY:

Bill ask price = (FV) / [1 + (BEY * (D2m/365)]

Formula for Current Price:

CP = FV * [1-(days to mat/360)*(discount yield)]

Which one of the following rates is used by brokerage firms as the basis for determining margin loan rates?

Call money

Market Segmentation Theory

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

Which one of the following rates is the rate that banks charge each other for overnight loans of $1 million or more?

Federal funds

Bond equivalent yield:

Formula for converting a bank discount yield to a bond equivalent yield: BEY = (365*Discount Yield) / [360 - (days to mat*discount yield)]

Federal funds rate

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

London Interbank Offered Rate, LIBOR

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

Bellwether rate

Interest rate that serves as a leader or as a leading indicator of future trends, e.g. , interest rates as a bellwether of inflation.

Certificate of deposit, CD

Large-denomination deposits of $100,000 or more at commercial bank for a specified return.

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 large corporations.

Which one of the following debt instruments guarantees investors a positive real rate of return?

TIPS

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, which are bank loans to brokerage firms. This rate is used as the basis for customer rates on margin loans.

Discount rate

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

Term structure of interest rates

The relationship between time to maturity and the interest rates for default-free, pure discount instruments; can be seen by examining yield on US Treasury STRIPS

Expectations Theory

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

Eurodollars

U.S. dollar denominated deposits at foreign banks or foreign branches of U.S. banks.

Basis point

With regard to interest rates or bond yields, one basis point is 1% of 1%.