Question

Table below presents information on three US Treasury bonds:

Maturity	Coupon Rate	Price (per $100 of Face value)
6 months	1%	99.75
12 months	2%	100.5
18 months	1.5%	98.5

Use this information to answer the following questions:

1. Is term structure increasing or decreasing? Please provide the explanation for the main reason for the term structure being increasing or decreasing.

Answer 1

Term Structure shows the relation between Bond Coupon rate to its maturity. When the short term rate is lower than the long term rate we say term structuring is increasing, as its an upward sloping curve and when short term rate is higher than long term rates term structure is decreasing, as its a downward sloping curve.

The shape of the curve can change over time based on the various microeconomic and Macroeconomic factors like ( inflation, GDP growth rate, etc)

When the investor expects that the economy is going to do well, we see an upward slowing term structure curve. when the economy is growing the inflation rate is expected to go up ( considering that the demand of goods and services will increase faster than the supply) and hence the long term maturity coupon rate will be higher than the short term

In the above table, we see that the coupon rate is increasing from 1% to 2% for 6-month to 12-month maturity respectively and then decreasing to 1.5% for 18-month maturity. this indicates that the economy is expected to slow down ( demand for goods and services is expected to come down) and thus the term structure curve will slow downwards and hence the term structure is decreasing.