Section 4

Question 1

Define yield curve

Answer 1

the relationship between maturity and yield is known as the yield curve

it is a snapshot in time of the GRY on a range of fixed income securities with different maturities (but similar credit risk).

Question 2

what is a benchmark yield curve

Answer 2

yield curve constructed from government securities (gilts in the case of the UK) - they are the basis for evaluating other yields of similar maturity bonds

Question 3

what is pure expectations theory

Answer 3

states that in equilibrium, the long term rate is a geometric average of today’s short term rate and expected short term rates in the future.

Question 4

what does pure expectations theory imply?

Answer 4

that there is an implicit relationship between current fixed income yields and forward rates

Question 5

what is a forward rate?

Answer 5

forward rates are an expected future short term interest rate.

Question 6

what is a spot rate

Answer 6

a single quoted rate from now up to a specified future point in time.

They are a geometric average of the current short-term rate together with all other forward rates up to that point in time

Question 7

what. is the yield of a bond in terms of spot rates

Answer 7

a complex weighed average of the spot weights. the weightings re roughly the cash flows paid out by that bond.

Question 8

for a zero coupon bond what will the yield equal?

Answer 8

the spot rate for the particular time horizon as all cash flows will be returned at one maturity date

Question 9

for an upward sloping yield curve where the bonds are not zero coupon what relationship holds

Answer 9

forwards > spots > yield

Question 10

for a downward sloping yield curve where the bonds are not zero coupon what relationship holds

Answer 10

forwards < spots < yield