Topic 11 Yield Curve

Question 1

The Yield Curve

Answer 1

Graphical representation of bond yield vs maturities

Question 2

Spot Rate

Answer 2

Rate per period agreed at time 0 y0,i for investment between time 0 and i

Question 3

Forward Rate

Answer 3

Rate per period that is agree at time 0 f i,j for future investment between i and j - guarantees a future rate through a contract to ensure return of rollover strategy

Question 4

expected spot rate, short rate

Answer 4

forecasted rate per period agreed at time i for an investment at time i between time i and time j -however will only know at time 1 of the actual investment

Question 5

Spot yields

Answer 5

-geometric average of spot rate and series of forward rates
*if yield to maturities differ
->must be because of forward rates

Question 6

Expectations Theory

Answer 6

-The yield curve reflects investors’ expectations of future interests rates
Forward rates f t-1,t=expected future spot rate E(r t-1,t)

Question 7

what does expectations theory say about future sport interest rates

Answer 7

upward slope - future spot interest rate going up
flat - future spot rates unchanged
downward sloping - future spot interest rates going down

Question 8

Liquidity Preference Theory

Answer 8

Longer term bonds are supposed to have higher risk than short term
thus long term bond holders require premium to compensate for higher risk
f t-1,t = E(r t-1,t) + illiquidity premium

Question 9

what does Liquidity Preference Theory say about future rates

Answer 9

upward slope - future spot rates could go up down or nothing depending on prem
flat - future rates to go down
down - future spot rate going down (a lot)