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Chapter 15
15-1
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Relationship between yield to maturity and maturity Information on expected future short term rates can be implied from yield curve The yield curve is a graph that displays the relationship between yield and maturity Three major theories are proposed to explain the observed yield curve
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15-2
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Yield Curves
Yields Upward Sloping Flat Downward Sloping Maturity
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15-3
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Year 0 (today) 1 2 3
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15-4
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15-5
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15-6
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(1 yn ) (1 yn1 ) (1 f n )
n
n 1
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15-7
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Note: this is expected rate that was used in the prior example
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15-8
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15-9
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0.102567
0.063336 0.063008
The McGraw-Hill Companies, Inc., 1999
= =
15-10
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15-11
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Expectations Theory
Observed long-term rate is a function of todays short-term rate and expected future short-term rates Long-term and short-term securities are perfect substitutes Forward rates that are calculated from the yield on long-term securities are market consensus expected future short-term rates
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15-12
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15-13
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15-14
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Liquidity Premium
Maturity
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15-15
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Short- and long-term bonds are traded in distinct markets Trading in the distinct segments determines the various rates Observed rates are not directly influenced by expectations Preferred Habitat - Modification of market segmentation - Investors will switch out of preferred maturity segments if premiums are adequate
15-16
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