Ngân hàng, tín dụng - Chapter 5: The term and risk structure of interest rates

1Copyright © 2009 Pearson Addison-Wesley. All rights reserved. Chapter 5 The Term and Risk Structure of Interest Rates Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-2 Learning Objectives • Envision and draw the yield curve and describe the determinants of its slope • Explain how risk is important in influencing interest rates • Comprehend the impact on interest rates of income taxes Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-3 The Term Structure of Rates and the Yield Curve • Term Structure—Relationship among Yields of different maturities of the same type of security • Yield Curve (Figure 5.1) – Graphical relationship between yield and maturity – Yield is measured on the vertical axis and term to maturity is on the horizontal 2Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-4 The Term Structure of Rates and the Yield Curve (Cont.) • Yield Curve (Figure 5.1) (Cont.) – The basic question—does the curve slope upward, downward, or horizontal (Figure 5.1) – In the real world yields on all maturities tend to move together while there are distinct, divergent patterns between movements in short-term and long- term yields. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-5 FIGURE 5.1 Three alternative yield curves. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-6 The Term Structure of Rates and the Yield Curve (Cont.) • Different Theories of the Shape of the Yield Curve – Supply and Demand • Determined by relative supply/demand of different maturities • Deals with each maturity by itself and ignores the interrelationships between different maturities of the same security 3Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-7 The Term Structure of Rates and the Yield Curve (Cont.) • Different Theories of the Shape of the Yield Curve (Cont.) – The Pure Expectations Approach • Short-term and long-term securities are very good substitutes for each other within investor’s portfolios who collectively impact the market • Therefore, there are not separate markets for short-term and long-term securities, there is a single market Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-8 The Term Structure of Rates and the Yield Curve (Cont.) • Different Theories of the Shape of the Yield Curve (Cont.) – The Pure Expectations Approach (Cont.) • These investors are interested in the return over the period and not the maturity date of the final payment • Implies that expectation of future short-term rates determines how long-term rates are related to short-term rates • Buying and selling pressure maintains the long-term rate as an average of current short-term rate and the expected future short-term rates Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-9 The Term Structure of Rates and the Yield Curve (Cont.) • Different Theories of the Shape of the Yield Curve (Cont.) – The Pure Expectations Approach (Cont.) • If expected future short-term rates are above current short- term rates—yield curve will be upward sloping • Alternatively, lower expected short-term rates will cause the curve to be downward sloping • The key to expectations theory is that short-term securities and long-term securities are good substitutes for each other 4Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-10 The Term Structure of Rates and the Yield Curve (Cont.) • Different Theories of the Shape of the Yield Curve (Cont.) – The Liquidity Premium Modification • Prices of long-term securities are more volatile • Possibly suffer capital loss if owner needs to sell security prior to maturity • Prefer to hold short-term securities for liquidity • Demand liquidity (risk) premium for exposure to price uncertainty with long-term securities • Suggests long-term rates will always be higher than short- term Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-11 The Term Structure of Rates and the Yield Curve (Cont.) • Different Theories of the Shape of the Yield Curve (Cont.) – The Preferred Habitat Approach • Different investors actually have a preference for different maturities—depends on their liquidity needs • This suggests the supply/demand concept for different maturities will establish the specific rates for each maturity range • Changes in supply/demand can cause the rates to get out of line with expectations. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-12 The Term Structure of Rates and the Yield Curve (Cont.) • Different Theories of the Shape of the Yield Curve (Cont.) – The Preferred Habitat Approach (Cont.) • However, Investors will drop preferred habitat if rates get out of line with expectations and switch portfolio holdings • This portfolio adjustment will cause the rates to become more in line with the expectations theory 5Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-13 The Term Structure of Rates and the Yield Curve (Cont.) • Different Theories of the Shape of the Yield Curve (Cont.) – Real-World Observations • When interest rates are high relative to past rates, investors expect them to decline and the price of bonds to rise in the future resulting in big capital gains • Investors would then favor long-term securities, which drives up price and lowers yield—downward sloping yield curve (Figure 5.2) Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-14 FIGURE 5.2 Yields on U.S. government securities. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-15 The Term Structure of Rates and the Yield Curve (Cont.) • Different Theories of the Shape of the Yield Curve (Cont.) – Real-World Observations (cont.) • Opposite if interest rates are low relative to past—results in an upward sloping curve • Historically, over the business cycle short-term rates fluctuate more than longer-term rates (Figure 5.3) • Yield curves tend to be upward sloping more often, suggesting the liquidity premium is the dominant theory 6Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-16 FIGURE 5.3 Three different Treasury rates. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-17 The Term Structure of Rates and the Yield Curve (Cont.) • Different Theories of the Shape of the Yield Curve (Cont.) – Summary of term structure theory • Expectations theory forms the foundation of the slope of the curve • Liquidity premium theory makes a long-term permanent modification that suggests an upward sloping curve • Over short periods, relative supplies of securities have an impact on yields, altering the shape of the curve Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-18 The Term Structure of Rates and the Yield Curve (Cont.) • Different Theories of the Shape of the Yield Curve (Cont.) – An Aside on Marketability • Recently issued government bonds (current coupon—“on the run”) are more marketable as compared to older issues (“off the run”) • Because these newly issued bonds are highly marketable, they carry somewhat lower yields to maturity as compared to older issues 7Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-19 Risk and Tax Structure of Rates • Default Risk – Other than US Federal government securities, bonds carry a risk of default – Risk on municipal bonds used to be considered very low – However, experience of New York City (1975), Cleveland (1978) and Orange Country, California (1995) suggest these bonds are becoming riskier – Corporate bonds generally have a higher default risk than municipal bonds – Investors will expect higher return to compensate for increased default risk Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-20 Risk and Tax Structure of Rates (Cont.) • Default Risk (Cont.) – Standard and Poor’s and Moody’s Investors Service rate the default risk on bonds which serve as a guide to investors – The introduction of risk in the yield curve will cause the curve to shift since another variable other than “maturity” has changed – The higher the perceived risk, the greater the upward shift of the curve for that particular security (Figure 5.4) Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-21 FIGURE 5.4 Riskier securities carry higher yields. 8Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-22 Risk and Tax Structure of Rates (Cont.) • Tax Structure – Investors are concerned about the after tax return on bonds – Although municipal bonds are riskier than federal government bonds, tax exempt status of municipal bonds will generally result in a lower yield (downward shift of the curve) (Figure 5.4) Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-23 TABLE 5.1 A Guide to Bond Ratings Copyright © 2009 Pearson Addison-Wesley. All rights reserved. Appendix BOND PRICE VOLATILITY: DURATION VERSUS MATURITY 9Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-25 APPENDIX—BOND PRICE VOLATILITY: DURATION VERSUS MATURITY • Problem with relationship between bond price volatility and maturity stems from the way maturity is defined – Maturity is typically the date of final repayment of principal – This ignores the fact that the bond makes coupon payments before principal is repaid Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-26 APPENDIX—BOND PRICE VOLATILITY: DURATION VERSUS MATURITY (cont.) • More comprehensive measure of maturity is duration – Duration is defined as a weighted average of the time periods when a bond’s payments are made – Takes into account the timing of coupon and principal payments – A bond with longer duration has greater price volatility than a bond with short duration – The higher the yield to maturity, the lower the duration of a bond – Lower coupon payments mean longer duration – Duration always equals maturity for zero-coupon bond (and is less than maturity for bonds with coupons Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-27 TABLE 5A.1 Duration of Bonds with Different Maturities