Question

why do different kind of bonds have different levels of interest rates? why do interest rates increase and decrease over time? describe in detail the yeild curve and the expectation hypothesis.what does the yeild curve look like in the current economic environment ? if the yeild curve is steep, how would that affect your borrowing and investing decisions?

need it ASAP

Answer 1

Different kinds of Bond will be having different interest rate because they will be having different risk, different maturity, different expectations from investors and different structure of the bonds.

Generally those bonds who are having lower investment grade are always offering high interest rate in order to lure investors and to invest in them whereas the bonds which are having a higher credit rating and investment rating will not be offering high rate of interest.

Bonds which are of longer period and having longer duration are always prone to various market risk and investor will always be demanding a higher rate of interest for investing into those bonds rather than normal short term bonds so bonds with higher maturity will be providing with high amount of interest rates.

Interest rate increase and interest rate decrease over the time because there are certain monetary policies which are designed by central banks according to the need and the expectation of various stakeholders in economy and they are determining the interest rate in order to maintain the flow of money which will be in synchronisation with the current situation of the economy.

Yield curve is a curve which reflects plotting of bond on different maturity period of similar quality bonds and these will be reflecting the cycle of the economy and they can either be inverted yield curve for normal upward-sloping yield curve or flat yield curve.

expectation hypothesis will be reflecting that investor will always be demanding a higher rate of interest for investment into longer term bonds because there is higher risk associated with investment into longer term bonds because of their longer time maturity and exposure to market risk.

Yield curve is is trying to normalise itself and it is getting flattened because it has seen a recovery from downward cycle of the economy because of an expectation of impending recession but due to the stimulation provided by the central bank the yield curve has started to flatten.

steepening of yield curve will be happening in expectation of strong economic growth because there would be an increase in the difference between two bonds and long term bonds will be gaining on the upside because there is an expectation of increased inflation and increased economic growth. At these times, banks are generally offering a higher interest rate on loans so borrowing should be lesser and investment should be higher because there is a strong economy in order to gain from capital appreciation