Question

Problem 3. (A) Consider the following yield curves for German government bunds and Russian Treasury securities. Which theories of the term structure of interest rates can explain this shape of the yield curves? How can you explain the differences in rates for instruments with identical maturities? (15 points) Germany and Russia Yield Curves an or a ror or ser or lar zor 224 2er er 287 sor - Germany 21 Oct 2019) - Russia (21 Oct 2019) (B) How could a firm attract funds via capital market? (10 points)

Answer 1

A)
In this graph we see that the term structure is sloping upwards which means that bonds with longer maturities have higher interest rates. So, this is because of the fact that we expect growth in the economy and the inflation to be positive. To account for the inflation, longer tenure interest rates should be higher than the short term ones. This reflects in the upward sloping yield curve as depicted in the figure.

The difference in the bond rates for the same maturity is a reflection of the different risks that each bond carries. While the German bonds are considered safe and hence less risky and so the interest rates on these bonds are also lower. While the Russian bonds are comparatively more risky and carries a higher chance of default and so for the same maturity, the interest rate on the Russian bond is lower.

B)
A firm can attract funds in the capital market by either issuing shares in the capital market and thus getting funds through equity inflows wherein investors become shareholders in the firm. Alternatively, the firm can also issue bonds or debentures in the capital markets to raise funds through debt mode wherein the firm would have to return the money raised as per the terms of the debt.