Ch 3 4303 Essay

1268 WordsOct 23, 20126 Pages
Chapter 3 2. Although investors always have the option of purchasing risk free treasury securities, they may prefer some other securities if the yield compensates them for risk. Thus, if all other characteristics besides credit risk are equal, securities with a higher degree of risk will have to offer higher yield to be purchased. 3. Investors prefer securities that are liquid, meaning that they could easily be converted to cash without a loss in value. Thus, if all other characteristics are equal, securities with less liquidity will have to offer a higher yield to be preferred. Securities with a short term maturity or an active secondary market have greater liquidity. 4. Investors in high tax brackets benefit most from tax exempt securities, because taxable securities will have to offer a higher before tax yield to investors than tax exempt securities to be preferred. The extra compensation required on such taxable securities depends on the tax rates of individual and institutional investors. Corporate bonds have higher before tax yield, they are taxable by the federal government. Municipal bonds have higher tax yield for investors who are subject to high tax rates. Corporate bonds have a higher after tax yield only for low tax investors. Treasure bonds offer a lower yield because they are risk free. Required return on treasury bonds is lower. 5. According to the pure expectations theory, the term structure of interest rates is determined solely by expectations of future interest rates. There is a small demand for short term funds and downward pressure on the yield of short term funds. Also there is an increase in demand for long term funds by borrowers which places upward pressure on long term funds. Overall, the expectation of high ere interest rates changes the demand for funds and the supply of funds in different maturity markets which forces the

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