Question

Assume that yields on U.S. Treasury securities were as follows:

TERM RATE 6 months 4.15% 1 year 5.36 2 years 5.54 3 years 5.76 4 years 5.90 5 years 6.10 10 years 6.35 20 years 6.67 30 years 6.72

a. Select a correct yield curve based on these data.

b. What type of yield curve is shown?

c. What information does this graph tell you?

d. Based on this yield curve, if you needed to borrow money for longer than 1 year, would it make sense for you to borrow short term and renew the loan or borrow long term?

Explain.

Select a correct yield curve based on these data.

can you answer this please.....

Answer 1

Part a)

The yield curve is given as below:

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Part b)

The above curve shows an "Upward Sloping Yield Curve". It can also be called a "Normal Yield Curve" which exhibits lower yield for bonds with short-term maturity and higher yield for bonds with long-term maturity.

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Part c)

The graph shows that inflation is expected to increase in the future. With higher inflation, investors would expect a higher return on their investments, thereby forcing the bond issuers to offer higher yields for bonds with long term maturity. Another possible reason for higher yield in the long term could be the possibility of default on the part of the issuer in meeting its financial obligations. As the maturity period increases, the probability of default may increase. Investors would expect a premium to compensate them for this default risk.

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Part d)

No, it wouldn't make sense to borrow short term and renew the loan. It is because the interest rates are constantly increasing. As a result, borrowing and renewing at short term rates may result in an overall higher interest rate as compared to the one time high rate associated with long term borrowing.