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BKM 15_Hull4
both
6
Finance
Professional
03/11/2012
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Term
Value of FRA at any time
 Definition

party earning fixed rate -Rk

L*(RK-RF)(T2-T1)*e^(-R2T2)

 

Party earning floating rate

RF = current forward rate between T1 and T2

R2 riskless zero rate to T2

 

L*(RK-RF)(T2-T1)*e^(-R2T2)
Term
3 theories of yield curve
 Definition
  1. Expectations Hypothesis
  2. Liquidity preference
  3. Segmentation Theory
Term
Expectation Hypothesis
 Definition
forward rate equals the expected future short rate. Upward sloping curve implies expected rate increases.
Term
liquidity preference theory
 Definition

bond investors would select bonds which mature around the time they need the money.

Therefore you have short term investors

who would charge for interest rate risk if bought long term bonds

 

and long term investors

who would charge for reinvestment risk if bought short term bonds

 
Term
Segmentation Theory
 Definition

Short, medium and long term rates are seperate groups of investors

who do not switch readily. Therefore the rates are determined by supply and demand in each group.
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