2. Interest Rates

3. Relationship Between Different Interest Rates  Most interest rates of similar duration tend to be highly correlated  Short-term and long-term interest rates are loosely related  Most interest rates are determined directly or indirectly by the bond market

4. Interest Rates and Expected Inflation  Expected inflation : interest rates compensate for expectations of future inflation  Real Interest Rate : interest rate adjusted for inflation  TIPS : provide market-based estimates of the real interest rates  Difference between traditional Treasury and TIPS provides an estimate of expected inflation

5. Interest Rates and Risk  Risk premium (credit spread): difference between interest rate and interest rate on a comparable Treasury bond  Market-based measure of perceived risk of owning a particular bond  Rises somewhat during recessions as weaker companies face a higher chance of defaulting  “Extreme” levels are evidence of a financial crisis