Chp 9 Notes

Prime rate- the prime rate is a key short-term interest rate since it is the basis for
interest rates that large commercial banks charge on short-term loans to their most
trust corporate customers
-considered to be a bellwether rate-just an indicator of future trends;
like if someone says that interest rates as a bellwether of inflation
Call Money rate- the interest rate that brokerage firms pay for call money loans,
which are bank loans to brokerage firms. Call money, is the loan that banks give to
the security brokerage firm, and the call rate is the interest rate they pay.
This determines the basis for the interest rate they will charge their
customers who are buying on margin
Commercial Paper-short-term, unsecured debt given out by given out by large
corporations, banks and insurance companies
Large denomination cds can be sold amongst investors
Bankers acceptance-a postdated check on which a bank has guaranteed payment
(given if the goods are given)
London Interbank Offered Rate (LIBOR) is the interest rate offered by London
commercial banks for dollar deposits from other banks
The overnight repurchase rate, or repo rate, is the rate charged on overnight loans
that are collateralized by us treasure securities
Pure Discount Securities-Money market securities that just make a single payment
at the end of maturity
Basis point-with regard to interest rate or bond yields, one basis point is a percent
of a percet (0.0001)
Ex:interest rate goes from 5.82 to 5.94, the rate raised by 12 basis
points and the 5 is called the handle
Bank Discount basis is a method for quoting interest rates on money market
instruments
Money market rates are either bank discount rates (discount rates) or just APR on
things like CDs
Treasury yield curve impacts bond market analysis
Pure discount instruments with more than one year to maturity are called zero
coupon bonds

STRIPS are pure discount instruments created by stripping the coupons and
principal payments of us treasury notes and bonds into separate parts than selling
them separately
Real Interest rate=nominal interest rate-inflation
Fisher Hypothesis-the nominal interest rates follow the general level of inflation
In recent years, the us treasury has issued securities that guarantee a fixed rate of
return in excess of realized inflation rates
Term structure is the relationship between time to maturity and interest rate on
pure discount, default free US treasury STRIPS

The term structure reflects expectations of market participants about future changes in interest
rates and their assessment of monetary policy conditions.
Expectations theory-the term structure of interest rates is a reflection of market participants
belief in future interest rates
Forward rate-the implied future rate by comparing it with the current interest rate
There is a connection between the expectations theory and fisher hypothesis
If expected furture inflation is higher than current inflation, that we will likely see and upward
sloping term structure where long term interest rates are higher than short term
Maturity preference theory-long term interest rates contain a maturity premium necessary to
induce lenders into making longer-term loans (maturity premium)
Because lenders like shorter loans, and borrowers like longer loans
Maturity preference theory can also be added to expectations theory and fisher hypothesis
Market segmentation theory simply states that interest rates corresponding to each maturity are
determined separately by supply and demand conditions in each segment
Preferred habit theory is compromise between market segmentation and maturity preference.
Basically investors who have a certain preferred maturity can be induced to move more or less
preferred maturities by high interest rates. While in maturity preference theory, the preferred
habit is always shorter maturities.
Problems with modern term structure theory
-Term structure is almost always upward sloping but contrary to expectations theory, interests
rates have not always risen
-In terms of maturity preference, doesnt hold because one of the biggest borrowers US treasury
typically borrows short term, and pension funds generally tend to try to get long term.
-Market segmentation garbage because Us government borrows at all maturities. Also, many
investors are more than willing to move between maturities for better rates.

Default-free US government bonds still have higher interest then short term treasury bills. This
is because long term bond prices are much more sensitive to interest rate changes than short
term bonds (called interest rate risk!)