What is risk structure of interest rates?
The relationship among interest rates on bonds with the same maturity but different risk.
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| Term | Definition |
|---|---|
| What is risk structure of interest rates? | The relationship among interest rates on bonds with the same maturity but different risk. |
| What is default risk? | The risk that the bond issuer will not make interest or principal payments. |
| What is a risk premium? | The spread between interest rates on risky and risk-free bonds. |
| What causes risk premiums to increase? | Higher perceived default risk or lower liquidity. |
| What are U.S. Treasury securities considered? | Risk-free because the government can print money to pay debt. |
| What are junk bonds? | Bonds with ratings below BBB |
| What is liquidity in bond markets? | The ease with which a bond can be bought or sold without affecting its price. |
| What happens to bond prices when liquidity increases? | They rise. |
| What happens to interest rates when liquidity decreases? | They rise. |
| What are municipal bonds? | Bonds issued by state or local governments. |
| Why do municipal bonds have lower yields than Treasury bonds? | Because interest income is exempt from federal taxes. |
| What is the term structure of interest rates? | The relationship between yields and maturities of bonds with the same risk. |
| What are yield curves? | Graphs showing yields on bonds of different maturities. |
| What does an upward-sloping yield curve indicate? | Long-term rates are higher than short-term rates. |
| What does a downward-sloping yield curve indicate? | Short-term rates are higher than long-term rates (inversion). |
| What does a flat yield curve indicate? | Short and long-term rates are similar. |
| What are the three theories explaining the term structure? | Expectations theory, segmented markets theory, and liquidity premium theory. |
| What does the expectations theory state? | Long-term rates are the average of expected future short-term rates. |
| What does the segmented markets theory state? | Bonds of different maturities are not substitutes. |
| What does the liquidity premium theory state? | Investors demand a premium for holding long-term bonds. |
| What is the liquidity premium? | The extra yield on long-term bonds to compensate for higher risk. |
| Why is the yield curve usually upward sloping? | Because investors expect future short-term rates to rise or demand a liquidity premium. |
| What does an inverted yield curve often predict? | An upcoming recession. |
| How does default risk affect yields? | Higher default risk increases yields. |
| What is flight to quality? | Investors move from risky to safe bonds during crises, lowering Treasury yields. |
| What happens to corporate bond spreads in recessions? | They widen as risk perception increases. |
| What factors determine the risk premium? | Default risk and liquidity differences. |
| Why do Treasury bonds have lower yields? | Because they are highly liquid and default-free. |
| What happens to bond prices when risk increases? | They fall. |
| What is credit rating? | An assessment of a bond issuer’s creditworthiness. |
| Who provides credit ratings? | Agencies like Moody’s, S&P, and Fitch. |
| What is a BBB rating? | The lowest investment-grade bond rating. |
| What happens to yields if bonds become less liquid? | They increase. |
| How are municipal bonds taxed? | Interest is exempt from federal income taxes. |
| What is interest-rate risk? | The uncertainty about returns due to interest rate changes. |
| How can yield curves signal monetary policy? | Steep curves suggest expansion |
| What happens when expected future short-term rates fall? | Long-term rates fall. |
| What is the main message of the expectations theory? | Bonds of different maturities are perfect substitutes. |
| What causes the term premium? | Preference for short-term bonds and higher risk in long-term bonds. |
| How do expectations affect the shape of the yield curve? | Rising rate expectations steepen the curve |