ECON 3430 Lecture Notes - Lecture 9: Income Tax, Substitute Good

• School: York University
• Department: Economics
• Course: ECON 3430
• Professor: Ahmet Akyol

Document Summary

Chapter 6: the risk and term structure of interest rates. Risk structure of interest rates: bond yields differ (sometimes substantially) across bonds of similar maturity, key factors: Liquidity: the ease with which an asset can be converted into cash cost of selling a bond: number of buyers/sellers in a bond market. Flat: short- and long-term rates are the same. Explains the first two facts but not the third. Explains fact three but not the first two. Liquidity premium theory combines the two theories to explain all three facts. Let the current rate on one-year bond be 6% You expect the interest rate on a one-year bond to be 8% next year. Then the expected return for buying two one-year bonds averages (6% + 8%)/2 = 7% The interest rate on a two-year bond must be 7% for you to be willing to purchase it.