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# Chapter five

### The cost of money

Question | Answer |
---|---|

default risk premium(DRP) | the difference between the interest rate on a U.S treasury bond and a corporate bond of equal maturity and marketability |

expectations theory | the theory that the shape of the yield curve depends on investors expectations about future inflation rates |

inflation | the tendency of prices to increase over time |

inflation premium(IP) | A premium for expected inflation that investors add to the real risk-free rate of return |

interest rate risk | the risk of capital losses to which investors are exposed because of changing interst rates |

inverted(abnormal) yield curve | a nownward sloping yield curve |

liquidity preference theory | the theory that, all else being equal, lenders prefer to make short term loans rather than long term loans; hence they will lend short term funds at lower rates than they lend long term funds. |

liquidity premium(LP) | a premium added to the rate on a security if the security connat be converted to cash on short notice at a price that is close to the original cost. |

market segmentation theory | The theory that every borrower and lender has a preferred maturity and that the slopeof the yield curve depends on the supply of and the demand for loanable funds in the long-term market relative to the short term market. |

Maturity risk Premium(MRP) | A premium that reflects the interest rate risk; Bonds with longher maturities have greater interest rate risk |

nominal risk-free rate, Krf | The rate of interest on a security that is free of all risk; it is approximated by the T-Bill rate or the T-bond rate and includes an inflation premium |

Normal yield curve | An upward sloping yield curve. |

Production opportunities | The returns available within an economy from investments in productive(cash generating) activities. |

Real risk-free rate of interest, k* | The rate of interest that would exist on a default-free U>S> Treasury securities if no inflation were expected. |

Reinvestment rate risk | The risk that a decline in interest rates wil lead to lower when bonds mature and funds are reinvested. |

Risk | In a financial market context, the change that a financial asset will not earn the return promised. |

Term structure of interest rates | The relationship between yields and the maturities of securities. |

Time preferences for consumption | The preferences of consumers for current consumption as opposed to saving for future consumption. |

Yield curve | A graph showing the relationship between yields and maturities of securities. |

Created by:
$amoney
on 2006-11-08