This question is related to treasury bonds’ term structure. a. “A term structure of bond yields...

This question is related to treasury bonds’ term structure.

a. “A term structure of bond yields tells us how bond yields change over time.” Explain whether you agree or disagree with the statement.

b. When you observe a down-sloping yield curve, what may you say about the economy under the liquidity premium theory?

Solutions

Expert Solution

1)A term structure of bond yield states the relationship between interest rate or bond yield and various maturity periods.If the term is plotted on X axis and yield on Y axis than the yield increases with the increasing maturity period.The slope changes with the changes in the maturity period and will be high for longer maturity period.The graph represents the expectation of investors as they expect more interest for longer maturity period.As return from bond is risk free return so the expectation of return for various periods will be different for different period of time.

2)Liquidity means how readily assets are converted in cash .Liquidity premium theory stats that the investors prefer high liquid assets and high interest rates and shorter maturity for which they are ready to pay premium which will increase with the maturity period.Usually the graph of term structure is upward sloping as interest rate increases with increase in time but after some time it increases with decreasing rate,which is due to longer maturity periods due to which then graph becomes downward sloping.

jeff jeffy answered 1 year ago

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