Question

Read the attached write up of why the Yield Curve has predictive power. Once you are done, compose a 1 paragraph response to the questions below in a Word document. Submit this document to this dropbox.

Also, please note that these questions are fair game for exams. So if you are confused, please ask about them.

Questions;

- Which is more advantageous to the investor from a liquidity perspective: investing in one 5-year security, or investing in a series of five 1-year securities?

- Which of the two aforementioned investment choices should have a higher interest rate associated with it?

- If you saw a steeply upward sloping yield curve, what you infer about interest rates and economic conditions?

- If you saw an inverted yield curve, what you infer about interest rates and economic conditions?

- Should you believe your inference from the Yield Curve is going to be 100% accurate?

Answer 1

1]

Investing in a series of five 1-year securities is advantageous because short-term bonds tend to have higher liquidity than long-term bonds.

2]

The 5-year security should have a higher interest rate because the 5-year security will have a liquidity premium and higher interest rate risk.

3]

The long-term rates are higher than short-term rates. Short-term rates can be expected to rise. This type of yield curve points to a economy that is likely to expand.

4]

The short-term rates are higher than long-term rates. This type of yield curve points to a economy that is likely to contract.

5]

No, this is not a 100% accurate inference. However, historical studies suggest that this is the likely outcome.