The Economics of Money, Banking, and Financial Markets

Frederic S. Mishkin

ISBN #9781292094182

11th Edition

614 Questions

42,466 Students Helped

Homework Questions

Summary

Learning Objectives

Key Concepts

Example Problems

Explanations

Common Mistakes

Summary

This section explains the risk and term structure of interest rates. It outlines that bonds with the same maturity can have different interest rates because of varying levels of default risk, liquidity, and tax advantages, which together contribute to the risk premium. Furthermore, the term structure is explained by three key theories—the expectations theory, segmented markets theory, and liquidity premium (preferred habitat) theory—with the liquidity premium theory most successfully accounting for observed yield curve patterns. Overall, understanding these factors enables investors and policymakers to interpret bond yields and predict future economic trends.

Learning Objectives

Key Concepts

CONCEPT

DEFINITION

Definition: The study of how equilibrium levels of output and inflation are determined by the interaction of aggregate demand (planned spending) and aggregate supply (the economy’s capacity).

The study of how equilibrium levels of output and inflation are determined by the interaction of aggregate demand (planned spending) and aggregate supply (the economy’s capacity). •

Example Problems

Example 1

If junk bonds are "junk," then why do investors buy them?

Example 2

Which should have the higher risk premium on its interest rates, a corporate bond with a Moody's Baa rating or a corporate bond with a C rating? Why?

Example 3

Why do U.S. Treasury bills have lower interest rates than large-denomination negotiable bank CDs?

Example 4

In the fall of $2008,$ AlG, the largest insurance company in the world at the time, was at risk of defaulting due to the severity of the global financial crisis. As a result. the U.S. government stepped in to support AlG with large capital injections and an ownership stake. How would this affect, if at all, the yicld and risk premium on AIG corporate debt?

Example 5

Risk premiums on corporate bonds are usually anticyclical; that is, they decrease during business cycle expansions and increase during recessions. Why is this so?