Podcast
Questions and Answers
What is typically associated with a higher interest rate on Certificates of Deposit (CDs)?
What is typically associated with a higher interest rate on Certificates of Deposit (CDs)?
- Lower risk investments
- Monthly compounding
- Larger amounts of saving (correct)
- Shorter maturity periods
What is indicated by a higher 3-month interest rate compared to a 9-month interest rate?
What is indicated by a higher 3-month interest rate compared to a 9-month interest rate?
- Inverted yield curve (correct)
- Stable economic conditions
- Increased inflation rates
- Normal yield curve
What fundamental interest rate significantly impacts almost all market interest rates?
What fundamental interest rate significantly impacts almost all market interest rates?
- Discount rate
- Libor rate
- Prime rate
- Federal funds rate (correct)
Why might the Federal Reserve decide to cut its Federal Funds Rate?
Why might the Federal Reserve decide to cut its Federal Funds Rate?
What do banks need to maintain with the Federal Reserve?
What do banks need to maintain with the Federal Reserve?
What is the main reason for borrowing and lending transactions overnight among banks?
What is the main reason for borrowing and lending transactions overnight among banks?
What is a common outcome when short-term interest rates exceed long-term rates?
What is a common outcome when short-term interest rates exceed long-term rates?
What can a large-value CD allow an investor to do?
What can a large-value CD allow an investor to do?
What is the primary reason the Fed raises the federal funds rate?
What is the primary reason the Fed raises the federal funds rate?
What effect does lowering the federal funds rate typically have on consumer behavior?
What effect does lowering the federal funds rate typically have on consumer behavior?
What happens to the yield on T-bills during a financial crisis?
What happens to the yield on T-bills during a financial crisis?
Which of the following is NOT one of the Fed's dual goals?
Which of the following is NOT one of the Fed's dual goals?
What is the typical maturity range for commercial paper?
What is the typical maturity range for commercial paper?
Why is the yield spread typically larger during economic recessions?
Why is the yield spread typically larger during economic recessions?
What is generally true about the relationship between risk and required rate of return?
What is generally true about the relationship between risk and required rate of return?
What is the minimum denomination for issuing commercial paper?
What is the minimum denomination for issuing commercial paper?
When the Fed lowers the federal funds rate, which of the following is a likely outcome?
When the Fed lowers the federal funds rate, which of the following is a likely outcome?
How are Treasury bonds and notes typically sold in terms of their repayment?
How are Treasury bonds and notes typically sold in terms of their repayment?
What is the main difference between Treasury notes and Treasury bonds?
What is the main difference between Treasury notes and Treasury bonds?
What is a characteristic difference between CDs and T-bills?
What is a characteristic difference between CDs and T-bills?
What occurs when commercial paper is issued?
What occurs when commercial paper is issued?
What is the typical par value for Treasury notes and bonds?
What is the typical par value for Treasury notes and bonds?
What does a bond's bid price represent?
What does a bond's bid price represent?
How is the bid price of 100.3047 expressed in dollar terms for a $1,000 par value bond?
How is the bid price of 100.3047 expressed in dollar terms for a $1,000 par value bond?
What is the equivalent taxable yield of a 4% tax-free municipal bond for an investor in a 28% tax bracket?
What is the equivalent taxable yield of a 4% tax-free municipal bond for an investor in a 28% tax bracket?
If an investor has a tax bracket of 28%, which investment option yields a higher after-tax return?
If an investor has a tax bracket of 28%, which investment option yields a higher after-tax return?
Which formula represents the relationship between the yield of taxable bonds and the yield of municipal bonds?
Which formula represents the relationship between the yield of taxable bonds and the yield of municipal bonds?
What is the cutoff tax bracket where the after-tax yield of a taxable bond equals the yield on a muni bond?
What is the cutoff tax bracket where the after-tax yield of a taxable bond equals the yield on a muni bond?
What could cause yields on municipal bonds to be lower than those on taxable bonds with similar risk?
What could cause yields on municipal bonds to be lower than those on taxable bonds with similar risk?
If the interest rate on a taxable bond is 6%, what is the expected taxable yield for an investor in a 28% tax bracket?
If the interest rate on a taxable bond is 6%, what is the expected taxable yield for an investor in a 28% tax bracket?
A tax-free municipal bond has a yield of 4%. What is the result if an investor in a 38% tax bracket is comparing it to a taxable bond?
A tax-free municipal bond has a yield of 4%. What is the result if an investor in a 38% tax bracket is comparing it to a taxable bond?
Which of the following statements is true regarding capital gains on municipal bonds?
Which of the following statements is true regarding capital gains on municipal bonds?
What is the after-tax return for a 6% taxable investment if the tax rate is 38%?
What is the after-tax return for a 6% taxable investment if the tax rate is 38%?
Which investment strategy is preferred if the goal is to achieve a higher yield after tax?
Which investment strategy is preferred if the goal is to achieve a higher yield after tax?
What is the nominal coupon payment for a bond with a 6.5% coupon rate and a $1,000 par value?
What is the nominal coupon payment for a bond with a 6.5% coupon rate and a $1,000 par value?
Who is more likely to invest in municipal bonds (munis)?
Who is more likely to invest in municipal bonds (munis)?
What does the yield to maturity (YTM) represent for a bond?
What does the yield to maturity (YTM) represent for a bond?
What factor influences a bond's rating?
What factor influences a bond's rating?
If a bond is selling for 109.13% of its par value, what is its purchase price if the par value is $1,000?
If a bond is selling for 109.13% of its par value, what is its purchase price if the par value is $1,000?
Which statement is true about corporate bonds?
Which statement is true about corporate bonds?
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Study Notes
Certificates of Deposit (CDs)
- CDs are a type of investment where you deposit a fixed amount of money for a fixed period of time.
- Higher interest rates are associated with CDs that have a longer maturity and larger deposits.
- An inverted yield curve occurs when short-term interest rates are higher than long-term rates.
- This happens when the market anticipates the Federal Reserve (the Fed) to reduce the Federal Funds Rate soon due to economic changes.
Federal Funds Rate
- The Fed controls the federal funds rate which affects other interest rates in the market.
- Banks are required to maintain a certain amount of cash reserves with the central bank.
- The federal funds rate is the overnight interest rate at which banks borrow and lend reserves from each other to meet their reserve requirements.
- The Fed changes the federal funds rate to either promote economic growth or control inflation.
- The Fed raises the federal funds rate to cool down an overheating economy and control inflation.
- This increases borrowing costs, discourages borrowing and spending, while encouraging saving.
- The Fed lowers the federal funds rate to stimulate economic activity during periods of weakness.
- Lower interest rates make it cheaper to borrow, boosting investments, consumer spending and job creation.
Yields of T-bill and CD
- T-bills have a lower risk and a lower yield compared to CDs.
- During financial crises, investors lose confidence in banks, making CDs riskier and increasing the yield spread between T-bills and CDs.
Commercial Paper (CP)
- CP is a short-term debt issued by corporations.
- They typically mature in 1-2 months.
- CP has a minimum denomination of $100,000 and is held by money market mutual funds.
Treasury Notes and Bonds (T-notes and T-bonds)
- The U.S. Department of Treasury sells T-notes and T-bonds to borrow money.
- T-notes have maturities from 1 to 10 years, while T-bonds have maturities from 10 to 30 years.
- T-notes and T-bonds pay semi-annual coupons and their face value at maturity.
Municipal Bonds (Munis)
- Municipal bonds are tax-free bonds and are issued by state and local governments.
- Returns on munis are lower than taxable bonds with similar risk due to the tax-free feature.
- High tax-bracket investors are more likely to favor munis because they benefit from the tax-free interest payments.
Corporate bonds
- Corporate bonds are mid-term and long-term debt securities issued by companies.
- They represent fixed payments from a corporation to the bondholder.
- Bonds are quoted as a percentage of par value.
- Yield to maturity (YTM) summarizes a bond’s overall investment value and is the bond’s annual discount rate.
- A higher bond rating indicates higher credit quality and lower default risk.
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