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Chapter five

The cost of money

QuestionAnswer
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



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