Chapter 6: Risk and Term Structure of Interest Rates

The tendency for default risk on bonds to increase during economic recessions.

A phenomenon where investors shift their investments away from risky assets like corporate bonds and towards safer assets like government bonds, typically during periods of economic uncertainty or recession.

The difference in interest rates between risky bonds and safer bonds, reflecting the additional risk associated with the risky bonds.

The spread in interest rates between bonds with different maturities, reflecting the difference in risk and liquidity associated with different maturities.

The relationship between bond prices and interest rates where an increase in interest rates leads to a decrease in bond prices, and vice versa.

A type of analysis that compares the interest rates of bonds with the same maturity but different levels of risk, typically focused on the default risk of the issuer.

The difference in interest rates between tax-exempt municipal bonds and taxable Treasury bonds, arising from the tax advantage of municipal bonds.

The relationship between interest rates and bond maturities, showing how interest rates vary across different maturities at a given point in time.

The probability that the issuer of a bond will be unable or unwilling to make interest payments or repay the face value.

The spread between the interest rates on corporate bonds and government bonds with the same maturity.

The ease with which an asset can be converted into cash.

The spread in interest rates on different types of bonds of the same maturity. It reflects the different levels of risk associated with each bond.

The degree to which a bond issuer's financial health and ability to meet its obligations are assessed. This assessment helps investors understand the risk associated with investing in a particular bond.

The difference in yields between bonds of similar maturity due to tax considerations. For example, municipal bonds in the U.S. are tax-exempt, making them attractive to investors.

Bonds issued by national governments, generally considered to have the lowest default risk because governments can raise taxes or print money to repay their debts.

A graphical representation of the relationship between the yield (interest rate) of bonds and their time to maturity.

When long-term interest rates are higher than short-term interest rates.

When short-term and long-term interest rates are similar.

When long-term interest rates are lower than short-term interest rates.

The theory that the shape of the yield curve is determined by investors' expectations of future interest rates.

Bonds with the same risk, liquidity, and tax considerations but different maturities usually have different interest rates.

Interest rates on bonds with different maturities tend to move together over time.

When short-term rates are low, curves usually slope upwards. When they are high, curves tend to slope downwards and may become inverted.

Each maturity's interest rate is decided solely by its own demand and supply, independent of other maturities.

Investors prefer bonds of one maturity over another, influencing yield curve slopes.

The interest rate on a long-term bond is the average of short-term rates expected over its life, plus a premium due to supply and demand.

Bonds of different maturities are partially substitutable, meaning they can be swapped to some extent.

A positive premium added to the average expected short-term rate to reflect the liquidity of a long-term bond.

Investors have a preference for specific bond maturities and require a higher return for bonds outside their preferred habitat.

The PHT predicts upward sloping yield curves when most investors favor short-term bonds over long-term bonds.

The yield curve based on the liquidity premium/PHT is above the yield curve based on the expectations theory and has a steeper slope.

The premium investors demand for holding longer-maturity bonds due to their lower liquidity compared to shorter-maturity bonds.

The theory describes the shape of the yield curve based on market expectations of future short-term interest rates and the liquidity premium offered on bonds with different maturities.

The expected interest rate on a one-year bond one year from now. This is used to forecast future interest rates.

The expected interest rate on a one-year bond two years from now. It's derived using the relationship between current and future interest rates for different maturities.

The expected interest rate on a one-year bond n years from now. It's calculated using the current and future interest rates for different maturities and time horizons.

The formula used by financial institutions to forecast future interest rates. It incorporates current and future interest rates, as well as the liquidity premium.

The practice of using monetary policy tools to influence economic activity, focusing on short-term and risk-free interest rates.

The practice of using unconventional methods to stimulate the economy, often involving actions beyond traditional interest rate adjustments.

A type of unconventional monetary policy where central banks purchase long-term assets, aiming to lower long-term interest rates and stimulate the economy.