Interest Rate Markets Quiz 1

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1

The relationship between term to maturity and interest rates is known as the term structure of interest rates. The four main theories are:

hypothesis states that the shape of the term structure is solely determined by investors' expectations regarding short-term interest-rates over the life of long-term securities.

hypothesis states the only uncertainty about future interest rates is due to uncertainty about the underlying real interest rates. Since it is unlikely that the amount of money and desired terms available for investment would match the borrowers needs, a premium must be paid to offset the risk of fluctuation.

premium suggest the only risk is due to unexpected changes in inflation.

hypothesis implies there is a distinct group of investors for certain maturity ranges.

2

The debt securities market consists of

and investors who negotiate the

at which the investor lends money to the

.

3

In Australia there are two distinct segments to the debt market: the

-

securities market ( often called the money market ) and the

-

securities market ( often called the fixed interest market ).

4

Money market instruments generally do not have any

and mature in

than one

.

5

Fixed interest securities have maturities of greater than one

and have regular

flows called

.

6

Identify each security as short-term or long-term

short-term long-term
indexed securities
Commonwealth Government bonds
cash
semi-government loans (semis)
promissory notes (PNs) or commercial paper (CP)
bank transferable certificates of deposit
bank endorsed bills of exchange
corporate bonds
commercial bills
asset-backed securities
bank-accepted bills of exchange
floating-rate notes and bonds
Treasury Notes (TNs)
certificates of deposit (CDs)

7

The

debt market is made up of all the individual private investors with their relatively

amounts of money.

8

The

debt market consists of the large pool of funds gathered together from the retail market. The participants are financial

and

corporations (professional investors).

9

Financial markets have two sub-markets:
* a

market where new securities are issued
* a

market where existing securities are traded.
Short-term and long-term securities may be issued on the primary market by:
*

/

Bids are accepted for a fixed volume of stock to be issued.
*

Specific deals are negotiated privately between the borrower and lender.
*

The arrangement between issuer ______ is such that the issuer pays each ______ _____ member a fee (retainer) in exchange for an agreement whereby each panel member will make a market (buy/sell spread) in each of the issuer's stocks and purchase stock from the issuer on an exclusive basis. This method of issuance is preferred by the

-

authorities.
*

This is where a borrower sets an interest rate for a particular period of time and issues a prospectus.

10

The basic objective of trading debt securities on the secondary market is to profit from

.

11

bonds provide the

for evaluating yields on other fixed interest securities. Most prices for corporate bonds are quoted as spreads over Government bonds. Given the increased liquidity in the Australian interest rate

market in recent years, corporate bonds are often prices as a spread to

.

12

The price paid for the use of money is the

.

13

The RBA uses monetary policy to influence the

of

and the

of

in the economy.

14

A tightening of monetary policy

liquidity in the financial system and in the short term puts

pressure on interest rates. As this will tend to

inflation, this policy in the longer term will lead to an

of interest rates. Conversely, an easing of monetary policy will

interest rates in the short term and may lead to an

in the longer term.

15

funds theory assumes an equilibrium interest rate is set by supply an demand being in balance.

16

The

equation explains the relationship between interest rates, inflation and the real rate of return mathematically.

17

states that the interest rates between countries vary only be expected exchange rate movements.

18

An increase in the level of inflation puts upward pressure on interest rates as:
* production costs

, making Australian products

competitive
* the real rate of return on investment

and hence investors will require

interest rates to compensate for this loss.
* wages

and hence the price of producing goods

this can lead to spiraling

.

19

If plans to borrow exceed plans to lend, interest rates may

. If plans to borrow fall short of plans to lend, interest rates may

.

20

is an important indicator of how short-term interest rates will move.

21

Approaches to interest rate forecasting include:
*

will allow a better assessment of the risks to the forecasts.
*

forecasting
*

modeling
*

is important to understand short-term pricing conditions in markets.

22

There are four components to building an interest rate forecast:
* assessment of

. The start point is to look at the money markets.
* creating an

. It is important for the forecaster to construct a view on the future course of economic growth and inflation.
* the

forecasts. The starting point is the cash rate.
* strategy and


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