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Chapter 6: Q.8 (page 188)

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?

Short Answer

Expert verified

Lower interest rates on corporate bonds and higher interest rates on government securities will arise from increased demand for corporate bonds and decreased demand for treasury securities.

Step by step solution

01

Introduction

A bond is a fixed amount of income investment that is given to an entity for a specific length of time.

Treasury securities are the bonds issued by the United States government. These securities have varying maturities, with Treasury Bills being the issuance having the shortest maturity.

02

To determine

Interest rates on corporate bonds and Treasury securities are affected.

03

Explanation

After the government guarantees corporate debts, the danger of default will be decreased, making these bonds more desirable to the public. The demand for corporate bonds will rise as a result of this.

Lower interest rates on corporate bonds and higher interest rates on government securities will arise from increased demand for corporate bonds and decreased demand for treasury securities.

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Most popular questions from this chapter

Figure 7 shows a number of yield curves at various points in time. Go to http://www.bloomberg.com/ markets/rates/index.html and find the data for U.S. Treasury yields for different maturities. Does the current yield curve fall above or below the most recent one listed in Figure 7? Is the current yield curve flatter or steeper than the most recent one reported in Figure 7?

The table below shows current and expected future one-year interest rates, as well as current interest rates on multi-year bonds. Use the table to calculate the liquidity premium for each multiyear bond.

Suppose the interest rates on one-, five-, and ten-year U.S. Treasury bonds are currently 3%,6%and 6%respectively. Investor A chooses to hold only one-year bonds, and Investor B is indifferent with regard to holding five- and ten-year bonds. How can you explain the behavior of Investors A and B?

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?

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