interest rates and shit

Question 1

The Yield Curve

Answer 1

plot of yield to maturity as a function of time to maturity

displays the relationship between YTM and time to maturity

Information on expected future short-term rates can be implied

Question 2

are Yields on different maturity bonds equal?

Answer 2

no

Question 3

Bond stripping and bond reconstitution may offer opportunities for what under Law of One Price?

Answer 3

for arbitrage

Question 4

can bond coupon payments be seen as individual coupon bonds?

what does this mean for bond prices

Answer 4

yes

we need to discount every cash flow (bond and principal) at the appropriate discount rate corresponding to the maturity of this CF

Question 5

Stripped bonds

Answer 5

zero-coupon bonds created by selling each coupon (or principal payment) made by the governments’ bond as a separate cash flow

Question 6

how to determined the price of stripped bonds

Answer 6

To determine the price of its zero-coupon bonds we need to obtain their present value

Question 7

There different yield curves used in the market

Answer 7

Pure yield curve

On-the-run yield curve

Question 8

Pure yield curve

Answer 8

this is the yield curve for stripped or zero-coupon bonds

Question 9

On-the-run yield curve

Answer 9

constructed from the YTM of different maturities recently issued coupon paying bonds

Question 10

the Spot Rate

Answer 10

the yield to maturity on zero-coupon bonds

refers to the interest rate valid from today till the maturity of the corresponding zero-coupon bond

the geometric average of its component short rates

Question 11

Short rate

Answer 11

refers to interest rate available for a specific time interval at a specific period of time

Question 12

how to calculate short rate

Answer 12

r2 = (1 + y2) / (1 + r1) - 1

Question 13

how to calculate the spot rate for two year holding period

Answer 13

y2 = ((1 + r1)(1 + r2))^(1/2)

A spot rate is the geometric average of its component short rates

Question 14

why does the long term yield curve slope up

Answer 14

because of interest risk premium

Question 15

when does the Yield curve slope up?

what could this indicate

Answer 15

When next year’s short rate, r2 > r1, the yield curve slopes up

May indicate rates are expected to rise

Question 16

when does the Yield curve slope down?

what could this indicate

Answer 16

When next year’s short rate, r2 < r1, the yield curve slopes down

Question 17

hot calculate a forward rate

Answer 17

(1 + fn) = ((1 + yn)^n) / (1 + yn-1)^(n-1)

Question 18

what happens to the liquidity premiums when short rates and forward rates are expected to remain constant?

Answer 18

liquidity premiums remain constant

Question 19

what happens to the liquidity premiums when short rates are expected to decline and forward rates are expected to increase?

Answer 19

liquidity premiums increases

Question 20

what happens to the liquidity premiums when short rates and forward rates are expected to remain decrease at the same rate?

Answer 20

liquidity premiums remain constant

Question 21

what happens to the liquidity premiums when short rates increase but forward rates are expected to remain increase even more at the same rate?

Answer 21

liquidity premiums increases

Question 22

The expectations hypothesis

Answer 22

states that forward rates correspond to the future interest rates expected by the market

Observed long-term rate is a function of today’s short term rate and expected future short-term rates

fn = E(rn) such that liquidity premiums are zero

Question 23

The liquidity preference hypothesis

Answer 23

states that the market is dominated by short term investors who require a premium to induce them to invest in longer term instruments instead of investing in short term ones

Question 24

Longer term rates being larger than shorter term rates lead to?

Answer 24

having higher forward rates than spot rates

Long-term bonds are more risky: fn > E(rn)

The excess of fn over E(rn) is the liquidity premium

The yield curve has an upward bias built into the long-term rates because of the liquidity premium

Question 25

what does an up sloping yield curve mean?

Answer 25

Rates are expected to rise

or

Investors require large liquidity premiums to hold long term bonds

Question 26

how is the yield curve is a good predictor of the business cycle?

Answer 26

Long term rates tend to rise in anticipation of economic expansion

Inverted yield curve may indicate that interest rates are expected to fall and signal a recession