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by: Elizabeth Gruber

Test PSC1001

Elizabeth Gruber
GPA 3.9

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Introduction to Comparative Politics
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Class Notes
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This 2 page Class Notes was uploaded by Elizabeth Gruber on Wednesday March 23, 2016. The Class Notes belongs to PSC1001 at a university taught by a professor in Fall. Since its upload, it has received 17 views.

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Date Created: 03/23/16
2/16 Interest Rates  Cost of Debt o Probability of defaulting o Liquidity  Factors o Production Opportunities o Time preferences for consumption o Risk o Expected inflation  Nominal vs. Real rates o r = any nominal rate o r* = “real” risk-free rate  compensates for waiting o r RFthe rate of interest on Treasury securities  Determinants of interest rates o r = r* + IP + DRP + LP + MRP o r = required return on a debt security o r* = real risk-free rate of interest  In every instrument o IP = inflation premium  In every instrument o DRP = default risk premium  Companies are rated -> determines this value  In corporate bonds o LP = liquidity premium  In corporate bonds o MRP = maturity risk premium  Longer the bond -> higher rate of return wanted  For long term bonds o See slide for what components go in the the interest rates for what interest rates o Practice HW 6  Answer D – AAA 5 yr bond  Low risk of default  Lower MRP b/c shorter o Yield curve and the term structure of interest rates  Yield curve – graph  Usually upward sloping o Due to an increase in expected inflation and increasing maturity risk premium  Shows term structure  Long term rates are an average of the short term rates  Term structure – table  Relationship between interest rates (or yields) and maturities  Constructing the yield curve:  Inflation o Find the average expected inflation rate over years 1 to N o IP N (sum of inflation rates for N years)/N  Maturity Risk o Find the appropriate maturity risk premium o MRP = t.1%(t – 1)  Add the premiums  rRF,t r* + IP t MRP t  Corporate bond spread -> difference between corporate bonds and treasury bonds b/c of LP and DRP o Pure Expectations Theory  Assumptions  MRP for treasury securities = 0  Long-term rates are an average of current and future short-term rates  If the pure expectations theory is correct, you can use the yield curve to “back out” expected future interest rates


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