1. STRUCTURE OF INTEREST RATES
CHAPTER 3
STRUCTURE OF INTEREST RATES
Dr. David P. Echevarria
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2. PRICING DEBT SECURITIES: QUALITATIVE FACTORS
Default Risk (chance of not getting your $ back at maturity)
Financial strength of the issuer
Business strengths of the issuer
Industry outlook
Term to maturity
Credit Agency Rating
Liquidity (how easy is it to buy or sell at intrinsic values?)
Size of the issue (float)
General market conditions
Characteristics of the secondary market in bonds
Dr. David P. Echevarria
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3. PRICING DEBT SECURITIES: QUALITATIVE FACTORS
Tax Status (is interest income taxable?)
Municipals vs. Treasuries vs Corporate debt issues
Before Tax Equivalent Yields
Ybt = Yat / ( 1 – Tx)
Dr. David P. Echevarria
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4. TERM STRUCTURE THEORIES
Pure Expectations Theory
Investor / borrower expectations and preferred maturities
Computing the forward rate (see page 54)
Liquidity Premium Theory
S-T securities typically more marketable that L-T
Increase in marketability, ceteris paribus, should result in lower YTM
Segmented Markets Theory
Investor preferences for certain maturities investment horizon
Nature of assets and liabilities (matching principle)
Dr. David P. Echevarria
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5. TERM STRUCTURE OF INTEREST RATES
Comprehensive Explanation for Term Structure and Shape of the Yield Curve
The yield curve has much to do with investor expectations about the economy.
Lenders prefer less risk and more liquidity.
Borrowers prefer longer terms.
Implications of flat and inverted yield curves
Dr. David P. Echevarria
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6. Inverted Yield Curve Nov 14, 2000 Dr. David P. Echevarria
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7. Yield Curve Aug 29, 2011
Dr. David P. Echevarria
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8. Yield Curve 8/28/2013
Dr. David P. Echevarria
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9. Yield Curve 8/28/2014
Dr. David P. Echevarria
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10. HOMEWORK Briefly describe the implications of the following theories;
Pure Expectations Theory
Liquidity Premium Theory
Segmented Markets Theory
What factors do we consider when investing in bonds?
Why is the normal shape of the Yield Curve upward sloping to the right?
What do we mean by a before-tax equivalent yield and why is it important?
What is a forward rate and Why is it important?
Dr. David P. Echevarria
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