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Chapter 6: Q. 19 (page 189)

If the yield curve suddenly became steeper, how would you revise your predictions of interest rates in the future?

Short Answer

Expert verified

A decrease in the expected future interest rate implies a decrease in the slope of the yield curve.

Step by step solution

01

Definition

A yield curve is a curve that helps in studying at a given time, the relationship between the interest rate and maturity. It is also used to study a trend, the shape, the slope, and, the level of the yield curve.

02

Explanation

The slope of the yield curve provides clues about the direction of the movement of the interest rate in the future. A suddenly steeper slope of the yield curve implies an upward movement in the interest rate. This will lead to a higher long-term interest rate in the future. Thus the expected rate of average short-term interest rate would rise.

A decrease in the predicted future interest rate, on the other hand, would result in a decrease in the yield curve's slope.

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Most popular questions from this chapter

Following a policy meeting on March 19,2009the Federal Reserve made an announcement that it would purchase up to $300billion of longer-term Treasury securities over the following six months. What effect might this policy have on the yield curve?

Go to the St. Louis Federal Reserve FRED database, and find data on Moody’s Aaa corporate bond yield (AAA) and Moody’s Baa corporate bond yield (BAA). Download the data into a spreadsheet.

a. Calculate the spread (difference) between the Baa and Aaa corporate bond yields for the most recent month of data available. What does this difference represent?

b. Calculate the spread again, for the same month but one year prior, and compare the result to your answer to part (a). What do your answers say about how the risk premium has changed over the past year?

c. Identify the month of highest and lowest spreads since the beginning of the year 2000. How do these spreads compare to the most current spread data available? Interpret the results.

If bond investors decide that 30-year bonds are no longer as desirable an investment as they were previously, predict what will happen to the yield curve, assuming (a) the expectations theory of the term structure holds, and (b) the segmented markets theory of the term structure holds.

If the income tax exemption on municipal bonds were abolished, what would happen to the interest rates on these bonds? What effect would the change have on interest rates on U.S. Treasury securities?

Assuming the expectations theory is the correct theory of the term structure, calculate the interest rates in the term structure for maturities of one to four years, and plot the resulting yield curves for the following paths of one-year interest rates over the next four years:

a. 5%;7%;12%;12%

b.7%;5%;3%;5%

How would your yield curves change if people preferred shorter-term bonds to longer-term bonds?
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