Question

NEW YORK, Oct 31 (Reuters) - The U.S. Treasury yield curve was flatter in early trading on Thursday after data showing a marginal rise in consumer spending in September cast doubts on consumers' ability to continue driving the economy as business investment slumps. Yield curve indicates the term (-maturity) structure of interest rates in an economy. It shows interest rates for different terms (maturity). Typically, if the market is expected to grow, yield curve will have a positive (upward sloping) slope indicating that interest rate will grow as the economy is expected to grow interest rates are often positively correlated with GDP, inflation etc.). Conversely, if the economy is expected to go down, yield curve will become flatter. As this implies how the market thinks of the future economic trends, it is often used as an indicator of future economic performance. Rate ο Α Term (years)

Suppose the yield curve of an economy becomes B from A (the yield curve became flattened), which of the following statements are CORRECT? (*Note: This question was set to be multiple answer instead of multiple choice by mistake. You are supposed to choose only one of the following options.)

i. Duration of a coupon bonds have been increased.

ii. % Change in duration for high coupon bonds are higher for high coupon bonds than small coupon bonds (both have the same maturity).

iii. If there were two par bonds (one short maturity coupon bond and the other long maturity coupon bonds), short maturity bond much be traded at higher price now.

A. i

B.ii

C. i and iii

D. ii and iii

Please help me answer this question. Thank you very much!!

Answer 1

Answer: D. ii and iii

i. True, As yield declines, it leads to the lower payout from the bond. As payout declines, it leads to more duration for the bond.

ii. % Change in duration for high coupon bonds are higher for high coupon bonds than small coupon bonds (both have the same maturity) - False, We can't say.

iii. If there were two par bonds (one short maturity coupon bond and the other long maturity coupon bonds), short-maturity bonds much be traded at a higher price now. - True, Short maturity bonds may go up or show less decline compare to long-maturity bonds.