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Interest Rates

Interest Rates

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Interest Rates

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  1. Interest Rates

  2. Relationship Between Different Interest Rates • Most interest rates of similar duration tend to be highly correlated • Short-term and long-term interest rates are loosely related • Most interest rates are determined directly or indirectly by the bond market

  3. Interest Rates and Expected Inflation • Expected inflation: interest rates compensate for expectations of future inflation • Real Interest Rate: interest rate adjusted for inflation • TIPS: provide market-based estimates of the real interest rates • Difference between traditional Treasury and TIPS provides an estimate of expected inflation

  4. Interest Rates and Risk • Risk premium (credit spread): difference between interest rate and interest rate on a comparable Treasury bond • Market-based measure of perceived risk of owning a particular bond • Rises somewhat during recessions as weaker companies face a higher chance of defaulting • “Extreme” levels are evidence of a financial crisis