The U.S. Treasury issues some bonds as Treasury Inflation Indexed Securities, or TIIS, which are bonds adjusted for inflation; hence the yields can be roughly interpreted as real interest rates. Go to the St. Louis Federal Reserve FRED database, and find data on the following TIIS bonds and their nominal counterparts. Then answer the questions below.

• 5-year U.S. Treasury (DGS5) and 5-year TIIS (DFII5)
• 7-year U.S. Treasury (DGS7) and 7-year TIIS (DFII7)
• 10-year U.S. Treasury (DGS10) and 10-year TIIS (DFII10)
• 20-year U.S. Treasury (DGS20) and 20-year TIIS (DFII20)
• 30-year U.S. Treasury (DGS30) and 30-year TIIS (DFII30)

a. Following the Great Recession of 2008– 2009, the 5-, 7-, 10-, and even the 20-year TIIS yields became negative for a period of time. How is this possible?

b. Using the most recent data available, calculate the difference between the yields for each of the pairs of bonds (DGS5 – DFII5, etc.) listed above. What does this difference represent?

c. Based on your answer to part (b), are there significant variations among the differences in the bond-pair yields? Interpret the magnitude of the variation in differences among the pairs.

Step by step solution

01

Step 1. Introduction

Bonds are debt instruments that are issued by the government on different levels, and corporations to raise funds. The investor receives the principal amount upon maturity. and interest.

02

Step 2. Explanation

a. The DFII5 was fell to -0.48% in November 2010. The DFII7 rate was -0.07% in October 2010. In decemeber 2011, the DFII10 rate fell to -0.01%. Similarly, the DFII20 rate in Aug 2012 was -0.07%. During that period, the inflation rate was expected to be higher than the nominal interest rate. These yields can be roughly interpreted as real interest rate. Thus, because of expected inflation rate being higher, the yeilds were negative.

b. The difference between the yeids for each pair of bonds has been given below:

4-Apr-2022	Nominal	TIIS	Difference
5 year	2.56	-0.72	3.28
7 year	2.52	-0.54	3.06
10 year	2.42	-0.41	2.83
20 year	2.64	-0.12	2.76
30 year	2.48	0.02	2.46

This difference represents the expected inflation.

c. The nominal yields are higher than that of inflation indexed. This is because the inflation indexed securities yields roughly represent real interest rate. The negative yields show tat inflation rate was expected to be lower. The above table shows that the difference is greater for securities with shorter periods. The longer peirod securities such as 30-year-TIIS show a smaller difference.

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