Topic 4 - Bonds ((iii) International yield curve comparisons)

Question 1

International Yield Curve Comparisons

Answer 1

Investors focus on the default-free yield curve for government bonds/ YTMs generally differ around currencies.

International interest rate differences are caused by a variety of factors including:

• Differences in national monetary and fiscal policies.
• Inflationary expectations.
• Implied forward exchange rates:

• By comparing the yield curves in two currencies, we can derive the term structure of implied forward exchange rates and therefore, implied currency appreciation or depreciation.

Question 2

Yield Curve Comparisons (definition)

Answer 2

Yield curve:

• Graph of YTMs of bonds with different maturities (e.g. 1-year, 2-year, 5-year, 10-year, 20-year government bonds of the same country)
• Shows the YTM computed on the same day as a function of the maturity of the bonds.
• Provides a meaningful estimate of the term structure of interest rates.
• To be useful, a yield curve must be drawn from bonds with identical characteristics except for their maturity.