Question

(i). Explain to the management the risks and opportunities given contemporary business conditions (Hint: upward slope of the yield curve). What is your advice to the firm? (ii). How demand and supply bond curves react under these conditions?

Answer 1

(I) Firstly talking about the yield curve, it is the graphical presentation that depicts the yield or profit an investor is foreseeing or expecting to receive if he lends a particular amount of money for a given period of time. the yield curve is typically upward sloping; as the time to maturity increases, so does the associated interest rate. In the upward slope of yield, the debt is issued for the longer term and when money is lent for the longer term it carries greater risk because of the reason of inflation or bankruptcy in the long run. Thus, when risks are more, more are the chances of opportunities and the yield on such contracts is generally greater than that proposed for short-term lower risk securities.

I would advise the firm to invest in the long-term debt instruments of the same credit characteristic as this will gives the yield curve an upward slope, also known as a positive yield slope.

(II) talking about the demand and supply in the upward yield curve, demand shifts upward bending supply, long-term bonds rises in price leading the yields to fall. While in the yield curve, short-term bond rates rise. This is an outcome when investors demand less short-term securities and more into the long-term securities. Thus, further suppliers of short-term securities reduce the prices to attract investors on this side.

*PLEASE RATE WITH A THUMBS UP *