Question

In: Finance

Use your own words (means no quotation no external reference) to explain what is a yield...

Use your own words (means no quotation no external reference) to explain what is a yield curve, and what information would you need to draw this curve? How would you distinguish among the shapes of a 'normal'yield curve, an 'abnormal' curve, and a 'humped' curve?

Solutions

Expert Solution

Yield curve is the curve drawn by plotting the curve with yield till maturity of various government securities (bonds and treasury bills) in y axis and maturity of treasury bills and bonds of various maturities in x axis. It is used as basis for deciding loan rates, mortgage rates, etc.

Information needed are the yield rates of various treasury bills and government bond of maturity ( less than 1 year) and long term government bonds of maturities( 2 years, 3 year, 10 years, 30 years ,etc.)

Normal Yield Curve: This curve is seen during economic expansion when demand of short term bonds are more than long term bonds. As a result prices of short term bonds are more than prices of long term bonds which causes decrease in yields of short term bonds and increase in yields of long term bonds.

Abnormal Yield Curve: This curve is seen during economic recession when demand of short term bonds is less than long term bonds. As a result prices of short term bonds are lower than prices of long term bonds which causes increase in yields of short term bonds and decrease in yields of long term bonds.

Humped Curve: Humped curve is obtained when yields of medium term bonds increases more as compared to short term and long term bonds. This is because demand and prices of short term and long term securities are more than medium term securities.

Best of Luck God Bless


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