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Chapter 6: Q. 20 (page 189)

If expectations of future short-term interest rates suddenly fell, what would happen to the slope of the yield curve?

Short Answer

Expert verified

Interest rates for short-term loans are projected to reduce in the future. As a result, the yield curve will have a downward slope.

Step by step solution

01

Definition

The yield curve shows the interest rates of bonds that have different maturity but same credit quality.

02

Explanation

It is given that the future short-term interest rates are expected to fall. As a result, the yield curve will slope downwards. If the short-term interest rates are expected to fall, people will expect the long-term interest rate to fall too.

If the yield curve slopes upwards, then the interest rates are expected to rise. A yield curve can also be flat. This is when the future long-term interest rates are expected to rise at the same time short-term interest rates are falling.

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Most popular questions from this chapter

Go to the St. Louis Federal Reserve FRED database, and find daily yield data on the following U.S. treasuries securities: one-month (DGS1MO), three-month (DGS3MO), six-month (DGS6MO), one-year (DGS1), two-year (DGS2), three-year (DGS3), five-year (DGS5), seven-year (DGS7), 10-year (DGS10), 20-year (DGS20), and 30-year (DGS30). Download the last full year of data available into a spreadsheet.

a. Construct a yield curve by creating a line graph for the most recent day of data available, and for the same day (or as close to the same day as possible) one year prior, across all the maturities. How do the yield curves compare? What does the changing slope say about potential changes in economic conditions?

b. Determine the date of the most recent Federal Open Market Committee policy statement. Construct yield curves for both the day before the policy statement was released and the day on which the policy statement was released. Was there any significant change in the yield curve as a result of the policy statement? How might this be explained?

Which should have the higher risk premium on its interest rates, a corporate bond with a Moody鈥檚 Baa rating or a corporate bond with a C rating? Why?

Following a policy meeting on March 19,2009the Federal Reserve made an announcement that it would purchase up to $300billion of longer-term Treasury securities over the following six months. What effect might this policy have on the yield curve?

Predict what will happen to interest rates on a corporation鈥檚 bonds if the federal government guarantees today that it will pay creditors if the corporation goes bankrupt in the future. What will happen to the interest rates on Treasury securities?

Go to the St. Louis Federal Reserve FRED database, and find data on Moody鈥檚 Aaa corporate bond yield (AAA) and Moody鈥檚 Baa corporate bond yield (BAA). Download the data into a spreadsheet.

a. Calculate the spread (difference) between the Baa and Aaa corporate bond yields for the most recent month of data available. What does this difference represent?

b. Calculate the spread again, for the same month but one year prior, and compare the result to your answer to part (a). What do your answers say about how the risk premium has changed over the past year?

c. Identify the month of highest and lowest spreads since the beginning of the year 2000. How do these spreads compare to the most current spread data available? Interpret the results.
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