1) If the Treasury yield curve is flat (horizontal), can we say that the investors expect...

1) If the Treasury yield curve is flat (horizontal), can we say that the investors expect that the inflation rates will go down in the future? Please state: Agree, disagree, or uncertain. 2) If the inflation rates are expected to stay the same (at the level we have now) in the future, we can conclude that the yield curve is flat (horizontal). Please state: Agree, disagree, or uncertain. 3) If the inflation rates are expected to go down in the future, then the yield curve should be down-sloping. Please state: Agree, disagree, or uncertain. 4) Is it possible to see that the inflation rate is expected to decline in the future but the yield curve is upsloping? 5) On the Treasury yield curve, if the yield of 1Y Treasury is 2%, and 10Y Treasury is 3.4%, then can we say that the maturity risk premium for 10Y bond must be 1.4%? 6) If we were given a corporate spread for AAA bond as 1.4%, can we produce the yield curve for AAA bonds simply assuming a vertical distance of 1.4% over the Treasury yield curve? 7) What do you think is the best way to calculate the Maturity Risk Premium?

Solutions

Expert Solution

(1)Disagree,If the Treasury yield curve is flat (horizontal), then generally it means that investors are not sure that about future growth & Inflation.

(2)Agree,If the inflation rates are expected to stay the same (at the level we have now) in the future, we can conclude that the yield curve is flat (horizontal).

(3)Agree,If the inflation rates are expected to go down in the future, then the yield curve should be down-sloping.

(4)No it is not possible to see that the inflation rate is expected to decline in the future but the yield curve is upsloping.

(5)On the Treasury yield curve, if the yield of 1Y Treasury is 2%, and 10Y Treasury is 3.4%, then maturity risk premium for 10Y bond will be 1.4%

as this is the premium need to compensate for the additional time horizon & risk taken by investor.

(6) If we were given a corporate spread for AAA bond as 1.4%, we can produce the yield curve for AAA bonds

simply assuming a vertical distance of 1.4% over the Treasury yield curve which was the risk premium over treasury bond for the time horizon

(7)To figure out the best way to calculate maturity risk premium for your investment, you'll start by identifying the bond you wish to purchase say a 10 year treasury bond.

and the maturity date it comes with and then you will need to find out the yield for risk free securities with same duration(time span) as you are looking to buy.

Mostly treasury securities are considered as risk free as it is backed by government of respective nation.

From there, you'll need to find and subtract the rate of the one-year Treasury bill from that of the 10-year Treasury bond.

This represents the minimum risk premium for buying a bond with a 10-year maturity.

Eg.-If current yeild of 1 year treasury bill is 2% and 10 year treasury bill is 3.4%, then risk premium will be 1.4%

jeff jeffy answered 1 year ago

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