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Chapter 6: Q. 19 (page 189)

If the yield curve suddenly became steeper, how would you revise your predictions of interest rates in the future?

Short Answer

Expert verified

A decrease in the expected future interest rate implies a decrease in the slope of the yield curve.

Step by step solution

01

Definition

A yield curve is a curve that helps in studying at a given time, the relationship between the interest rate and maturity. It is also used to study a trend, the shape, the slope, and, the level of the yield curve.

02

Explanation

The slope of the yield curve provides clues about the direction of the movement of the interest rate in the future. A suddenly steeper slope of the yield curve implies an upward movement in the interest rate. This will lead to a higher long-term interest rate in the future. Thus the expected rate of average short-term interest rate would rise.

A decrease in the predicted future interest rate, on the other hand, would result in a decrease in the yield curve's slope.

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Most popular questions from this chapter

Prior to 2008, mortgage lenders required a house inspection to assess a home’s value and often used the same one or two inspection companies in the same geographical market. Following the collapse of the housing market in 2008, mortgage lenders required a house inspection, but this inspection was arranged through a third party. How does the pre-2008 scenario illustrate a conflict of interest similar to the role that credit-rating agencies played in the global financial crisis?

In 2010 and 2011, the government of Greece risked defaulting on its debt due to a severe budget crisis. Using bond market graphs, compare the effects on the risk premium between U.S. Treasury debt and comparable-maturity Greek debt.

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?

During 2008, the difference in yield (the yield spread) between three-month AA-rated financial commercial paper and three-month AA-rated nonfinancial commercial paper steadily increased from its usual level of close to zero, spiking to over a full percentage point at its peak in October 2008. What explains this sudden increase?

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?
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