Suppose the yield curve today is upward sloping. a. What does this mean for expectations today...

Suppose the yield curve today is upward sloping.
a. What does this mean for expectations today of future rates if you believe the Expectations Theory? The Term Premium Theory? Why?
b. Suppose instead that we’re ending the growth stage of the business cycle. What does this suggest for how the slope will differ from today's slope. Why

c. You're pretty pleased with yourself for your work in a&b. However, you worked with book values of assets, debt and income. What do you think about this approach and why?

Solutions

Expert Solution

1.a. An upward sloping yield curve represents that there is an expectation of higher yield in the longer time frame.Expectation theory emphasizes that investors want a higher yield to invest in the longer term bonds because as they have lesser of risk and higher of yield. so they will demand an additional premium on the bond yields to invest in the longer time frame bonds. That is also what is advocated by the premium theory which suggests that investors will demand a higher yield for investing in long term bonds.

b. If we are exhausted with the growth stage of the business cycle, there would be maturity and decline and at those times there would not be any expectation of outperformance of the company. hence, there would not be any expectation of premium in the overall yield of longer term bonds. Once the company has entered into the maturity and the growth stage, the yield curve would be more of flattened as there will be no expectation of growth in the long run.

3. The measurement of asset value on the basis of their value in books of accounts is a traditional approach which involves no updation and readjustment of the value of assets as it is recorded at the traditional value and it is not adjusted and synchronised with the updated market value. These approaches are highly used when it comes to different kind of valuations because the market rate of different assers are highly complex and conflicting in nature as different sources provides with market rates which are not uniform with each other.

jeff jeffy answered 1 year ago

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