a. What is the yield curve? b. What might a downward-sloping yield curve imply about expected...

a. What is the yield curve?

b. What might a downward-sloping yield curve imply about expected future short term interest rates? Explain your answer.

c. Explain why a downward-sloping yield curve may indicate that the economy is expected to grow slower. What would a steep downward sloping yield curve imply about future inflation?

d. How would your answers in b. and c. differ if the curve was flat? if upward-sloping?

e. What does the yield curve look like in Australia today? Why? (Go to the RBA website -http://www.rba.gov.au/statistics/tables/ and get data for yields at different maturities at the most recently available data)

Solutions

Expert Solution

Ans a) A yield curve is a line that plots yields of bonds having equal credit quality with different maturity dates. The slope of the yield curve gives an idea of change of future interest rate and economic activity.

b) The slope of the yield curve provides an important direction of future short-term interest rates and economic activity. The downward sloping curve indicates expectations of lower rates in the future.

c) A downward sloping or inverted yield curve, shows that markets expect the economy to slow down and interest rates fall in the future. When markets fear an economic depression, they expect demand for money to go down, which will drive interest rates lower.A steep yield curve shows long-term bondholders expect the economy to upgrade quickly in the future. It also shows that bond markets anticipate prices to increase, or an inflationary trend.

d) Yes, it would be different if the curve was flat or upward sloping.In flat yield curve says that the market is at the point of inflection.It could go into either a depression or some economic pick-up. It indicates that activity is slowing down, and investors are uncertain about the future.In case of an upward sloping or normal yield curve may indicate that markets expect business-as-usual for the economy, no significant changes in (price rise).

e) Yield curve is flat in short term maturities. It is flat in mid-term vs short term maturities.

Rahul Sunny answered 1 year ago

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