Chapter 8 - Marketability, default risk, call privileges, prepayment risk, taxes, and other factors affecting interest rates. In this chapter, students will be able to see the effects of financial assets’ marketability, liquidity, default risk, call privileges, prepayment risk, convertibility and taxability upon their interest rates and prices; to understand why there are so many different interest rates within the global economy;. | Money and Capital Markets 8 C h a p t e r Eighth Edition Financial Institutions and Instruments in a Global Marketplace Peter S. Rose McGraw Hill / Irwin Slides by Yee-Tien (Ted) Fu Marketability, Default Risk, Call Privileges, Prepayment Risk, Taxes, and Other Factors Affecting Interest Rates Learning Objectives To see the effects of the marketability, default risk, liquidity, call privileges, prepayment risk, convertibility and taxability of various loans and securities upon their interest rates. To understand why there are so many different interest rates within the global economy. To learn how the “structure of interest rates” is built and why it changes constantly. Learning Objectives To appreciate the difficulties of forecasting interest rates and financial asset prices accurately. Introduction In the preceding chapter, we examined how expected inflation and security maturity affect interest rates. In this chapter, we will look at how some other factors influence . | Money and Capital Markets 8 C h a p t e r Eighth Edition Financial Institutions and Instruments in a Global Marketplace Peter S. Rose McGraw Hill / Irwin Slides by Yee-Tien (Ted) Fu Marketability, Default Risk, Call Privileges, Prepayment Risk, Taxes, and Other Factors Affecting Interest Rates Learning Objectives To see the effects of the marketability, default risk, liquidity, call privileges, prepayment risk, convertibility and taxability of various loans and securities upon their interest rates. To understand why there are so many different interest rates within the global economy. To learn how the “structure of interest rates” is built and why it changes constantly. Learning Objectives To appreciate the difficulties of forecasting interest rates and financial asset prices accurately. Introduction In the preceding chapter, we examined how expected inflation and security maturity affect interest rates. In this chapter, we will look at how some other factors influence interest rates: marketability, default risk, call privileges, taxation of security income, prepayment risk, and convertibility. Marketability and Liquidity Marketability – Can an asset be sold quickly? Marketability is positively related to the size and reputation of the institution issuing the securities and to the number of similar securities outstanding. However, marketability is negatively related to yield. Liquidity – A liquid financial asset is readily marketable. Moreover, its price tends to be stable and reversible. Default Risk Default risk – The risk that a borrower will not make all the promised payments at the agreed-upon times. Promised yield on a risky asset = risk-free interest rate + default risk premium Expected yield on a risky asset = S piyi pi = probability that the ith possible yield, yi, occurs Anticipated default loss on a risky asset = promised yield – expected yield Default Risk Source: Economic Trends, Federal Reserve Bank of Cleveland, July 2001 Default
