Question

Using any one term structure theory, explain the current dynamics in the global fixed income market with a specific focus on the yield curves.

Answer 1

Answer:

Term structure theory of Interest rate- This theory tells the relationship between yield of bond and the different maturities. Yield is nothing but the return on the bond. This theory tells the interest on similar kind of bonds but at different maturities. The term structure of interest rate shows the expectation of market participants in interest rates and relation with monetary policy. Yield increases with the longer maturities.

On the graph, term structure of interest is known as Yield curve. Yield curve plays an important role in indentifying current situation of economy. Term structure of interest rates have these shapes:

Upward sloping- This is a normal slope of the yield curve, it happens when long term yields are higher than short term yields. It shows that the economy is in expansionary mode.

Downward slpoing- When short term yields are higher than longer term yields. This is called as "Inverted" yield curve and it shows that the economy is in recessive period or about to enter.

Flat- It shows the little variation between short and long term yields. It Signals that the market cannot predict the future direction of the economy.

Term structure of interest rates and the direction of the yield curve are used to analyze the environment of credit market.