Which of the following statements is true? The Fed has maintained an extremely low short-term interest rate regimen since 2008 to boost consumption, investments, and economic growth. An upward-sloping labor supply curve represents a case in which the substitution effect of higher wages outweighs the income effect. Default risk premiums narrow with growth and expansion of the economy and widen duringrecessions because many more borrowers default on their debt during recessions. D. be unaffected. Six (6) months ago, the yield curve exhibited a slight downward slope. The upward sloping yield curve is referred to as the normal yield curve, probably because, historically, the upward sloping yield curve is the shape that has been observed most frequently. An upward sloping yield curve implies that interest rates are expected to be lower in the future. The message: lower taxes; lower interest rates. A downward- sloping, or “inverted,” yield curve is often thought to signal a future recession. To learn about the flat yield curve, read on to the next part of this series. Over the past six (6) months, long-term yields declined while short-term yields remained the same. In a rising economy, the credit spreads on high yield bonds (HYG) and investment-grade bonds (LQD) contract. The slope of the yield curve has proven to be a good forecaster of economic growth. Yield curves are usually upward sloping asymptotically: the longer the maturity, the higher the yield, with diminishing marginal increases (that is, as one moves to the right, the curve flattens out).. Question 47. If you take a 2-year bank loan, you would have to pay a lower rate of interest than a 5-year loan, which would be lesser than that of a 10-year loan. The added risk prompts investors to seek higher returns from longer-term bonds, leading to an upward-sloping yield curve, just like the current Treasury yield curve. As bonds pay only interest (the coupon) until maturity and pay face value at maturity, investors take longer to recover their principal. That means when the price level falls, most firms cannot adjust wages immediately, which leads to an increase in real production costs. List the five basic factors which explain the differences in interest rates on different securities at any point in time. Solution for An upward sloping yield curve is a(n) _____ yield curve. The longer time to recover the principal leads to a higher risk to bondholders, as the bonds become more susceptible to interest rate changes than shorter-term bonds. Yield curves generally slope upward. Then for this question (4.18) : “When the zero curve is upward sloping, the zero rate for a particular maturity is greater than the par yield for that maturity. A yield-curve inversion is among the most consistent recession indicators, but other metrics can support it or give a better sense of how intense, long, or far-reaching a recession will be. The normal upward-sloping yield curve follows the “Liquidity Preference Theory,” which suggests that investors wish to be compensated for holding longer-term securities. View this answer. e. An upward-sloping yield curve would imply that interest rates are … Question 47. Explain how the term structure of interest ratescan be used to help forecast future interest rates. As an upward-sloping yield curve is normal, the arbitrage opportunities it offers are limited. AN UPWARD sloping yield curve was maintained throughout the year despite the further reductions in yields sustained by the Government of Ghana's money market instruments. While short-term rates are low, yields are exhibiting an increasing trend with maturity. You'll generally see this type of yield curve when bond investors expect the economy to grow at a normal pace, without significant changes in the rate of inflation or major interruptions in available credit. We'll explore these below and then take a look at the what the current yield curve is saying. For example, an upward sloping yield curve predicts higher short-term rates in the future. If a yield curve is upward sloping, it means that long-term interest rate is higher than the short-term... See full answer below. According to the expectations theory of the term structure of interest rates, if the yield curve slopes _______, the markets expect short-term interest rates to _______ in the future. C. become upward sloping. 16. Twitter Stock Sees Sell-Off After Trump Ban, Faces Political Risks, HempFusion Has Big Debut on TSX, Offers Diversity in CBD Market, Why Your Credit Karma Scores Might Look Different, Affirm IPO Looks Like a Steal at Current Price, Investors Take Notice. C. inverted. Upward sloping yield curves (calculated from monthly average interest rates) for two months, July 2003 and July 2004, are compared in Chart 2. With reference to the data above, of the ones given below, which security did the market view as having the greatest default risk? An upward slope yield curve indicates that the economy may normally be functioning. Why does the curve indicate the position of the economy? Historically, the U.S. yield curve has been upward-sloping. The market segmentation theory assumes that investors are risk-neutral. Monitoring Yield Curve Adjustments As an analyst of a bond rating agency, you have been asked to interpret the implications of the recent shift in the yield curve. The reason for that is that debt issued for a longer term generally carries greater risk because of the greater likelihood of inflation or default in the long run. b. institutions choose investment maturities to match their liability maturities. If investors suddenly believe interest rates will increase, their actions may cause the yield curve to. Explain how and why default risk premiums vary over the business cycle. D. long-maturity bonds increase in price when interest rates increase. The yields of longer-maturity bonds tend to be higher than the yields of shorter-maturity bonds since the longer maturity bonds are riskier. An upward-sloping yield curve supports the liquidity premium theory. If 1-year Treasury bills have a yield to maturity of 7 percent, and 2-year Treasury bills have a yield to maturity of 8 percent, this implies the market believes that 1-year rates will be 7.5 percent one year from now. In this basic competitive model, the real wage adjusts in labor markets to balance supply and demand. Under the preferred habitat theory of interest rates, b. the long term spot rate is an average of the current and expected future short term interest rates, 15.A two-year interest rate is 7% and a one-year forward rate one year from now is. The normal yield curve is a yield curve in which short-term debt instruments have a lower yield than long-term debt instruments of the same credit quality. The yield on a 5-year corporate bond should always exceed the yield on a 3-year Treasury bond. How a Parallel Shift in the Yield Curve Works . Expectation theory which says that long term interest rates should reflect expected future short-term rates. This movement of the yield curve would benefit investors, as bond prices rise with falling yields. A normal, upward sloping yield curve is shown below. B. humped. 17. Evidence explaining the trends of yields on the Ghanaian money market could best be explained by the shift of market preferences for long-dated higher yielding securities. As an upward-sloping yield curve is normal, the arbitrage opportunities it offers are limited. Because the curve can summarize where investors think interest rates are headed in the future, it can indicate their expectations for the economy. D. flat. This is because: The default risk premium, the difference between a risky security and a U.S. Treasury security of similar term, is the investors' expected default loss rate on a portfolio of similarly rated securities. 14. c. Investors demand a higher return on longer-term securities with greater price risk and less marketability. Yield curve construction itself requires some formidable mathematics and is outside the scope of this book; we consider here the basic techniques only. As a consequence, the suppliers hire fewer workers and produce a smaller quantity of good… Long-Term Interest Rates: The Fed and the Shape of the Yield Curve Can the Demand Curve Ever Be Upward Sloping?. The demand curve … Explain why municipal bonds have lower yields than comparable corporate taxable bonds. 13. Default risk premiums vary _______ with the ________ of the security. In normal conditions, the yield curve is upward-sloping. Yield curves are usually upward sloping, but short-term interest rates are as likely to fall as to rise. First, it may be that the market is anticipating a rise in the risk-free rate. Bodie - Chapter 15 #12 Difficulty: Easy The par yield for a certain bond maturity is the coupon rate that causes the bond price to equal it's par value. Define the term default risk premium. Parallel shifts are the most common during these normal yield curves. The market segmentation theory allows for the possibility of a discontinuous yield curve. The graph earlier and almost any other yield curve’s graph you see would look ‘upward sloping.’ Upward Slope Yield Curve. 11. With reference to the above data, at what marginal tax rate would an investor be indifferent between owning the corporate bond and the municipal bond? Historically, the slope of the yield curve has been a good leading indicator of economic activity. Default risk premiums vary inversely with economic activity. A graph of the term structure of interest rates is known as a yield curve.For example, the following table shows the term structure of interest rates for Treasury securities as of J… The steeper the curve is, the impression is that the economy is normal and not in a recession like a scenario anytime soon. Since investors are concerned with the after-tax yield earned, they will bid up the prices (lower the yields) of municipal bonds compared to corporate bonds. Bond A is not putable; bond B is putable. It argues that forward interest rates corresponding to certain future periods must be equal to future zero interest rates of that period. It cannot explain the usual upward slope of the yield curve. The existence of an upward sloping yield curve proves that the liquidity preference theory is correct,because an upward sloping curve necessarily implies that firms must offer a maturity risk premium in order to induce investors to lend for longer periods. c. yields by maturity of securities with similar default risk. C. short-maturity bonds yield less than long-maturity bonds. b. B. become flat. If three-year securities are yielding 6% and two-year securities are yielding 5.5%, future short-term rates are expected to ______, and outstanding security prices are expected to ______. C) why yield curves tend to slope upward when short-term interest rates are low and to be inverted when short-term interest rates are high. The yield curves show the relationship between interest rates on bonds similar in terms except for maturity. A) why yield curves usually tend to slope upward. D) why yield curves have been used to forecast business cycles. 10. For the first question, the answer is true. If investors suddenly believe interest rates will increase, their actions may cause the yield curve to. According to the expectations hypothesis, an upward-sloping yield curve implies that the market is expecting future short-term interest rates to rise. If a recession is on the anvil, the rates across maturities may drop, resulting in a downward shift in the yield curve. The default risk premium, the difference between a risky security and a U.S. Treasury security of similar term, is the investors' expected default loss rate on a portfolio of similarly rated securities. D. be unaffected. There are two common explanations for upward sloping yield curves. 12. This is the how the yield curve normally looks, it has been referred to as the ‘normal yield curve’. In a growing economy, investors also demand higher yields at the long end of the curve … B. become flat. An investor earned 12 percent last year, a year when actual inflation. There are two common explanations for upward sloping yield curves. As bonds pay only interest (the coupon) until maturity and pay face value at maturity, investors take longer to recover their principal. A. normal. Most consumers prefer to pay lower prices for the goods and services they want. 10. c. Investors in corporate bonds should carefully gauge the positives of a contracting credit spread and the negatives of a rising interest rate to make an informed investment decision in this scenario. A. short-maturity bonds offer high coupon rates. When the economy is expanding, investors risk a rise in yields as the Fed increases interest rates in response to rising inflationary pressures. Select one: A. become inverted. A. humped B. inverted C. normal D. flat E. None of the options are correct. 19. B. long-maturity bonds are priced above par value. week lecture chapter 15: the term structure of interest rate problem sets question under the expectations hypothesis, if the yield curve is upward-sloping, the During a recession, investors should stay away from high yield bonds (HYG), as the credit risk associated with these bonds is generally higher during a recession. Upward sloping yield curves are a natural extension of the higher risks associated with long maturities. If the firm believes that interest rates will stay constant and it wants to use the current yield curve to bolster profits, which approach should the firm follow? Question text This means the marginal product will equal the real wage. Commercial banks, savings and loan associations, and finance companies traditionally have better profits when, 18. 15. E. none of the above. 38) An upward-sloping yield curve that indicates cheaper short-term borrowing costs than long-term borrowing costs is called as _____.A) normal yield curve B) inverted yield curve C) flat yield curve D) lognormal yield curve ANSWER: A AACSB: Analytical Thinking 39) A yield curve that reflects relatively similar borrowing costs for both short-term and long-term loans is called as _____. Upward sloping yield curves are a natural extension of the higher risks associated with long maturities. In an interest swap rate, when we receive floating, and pay fixed, in upward sloping yield curve, we are going to receive increase of cash flows and therefore going to pay fixed and so, the counterpart will be at a loss in slopping upward yield curve, and hence, we will have a credit risk that will be greater. Assume that annualized yields of short-term and long-term securities are equal. An upward sloping yield curve is a(n) _____ yield curve. Default risk premiums are usually smaller during periods of high economic growth. 1. A sharply upward sloping, or steep yield curve, has often preceded an economic upturn. Question 2 What must be the annual coupon rate for a $1000 face value bond with four years until maturity, a price of $983.44, and a yield to maturity of 8%? Typically, the term structure refers to Treasury securities but it can also refer to riskier securities, such as AA bonds. Assume that annualized yields of short-term and long-term securities are equal. When the yield curve is upward sloping, which is the majority of the time, long-term rates are higher than short-term rates, due to the increased inflation risk of longer maturities. So, this prediction of the expectations theory is inconsistent with the real world evidence. As an upward-sloping yield curve is normal, the arbitrage opportunities it offers are limited. Treasury and corporate security yields are often combined on the same yield curve. Why might this observation be true? So yields on longer-term Treasuries (TLT) are higher than intermediate-term (IEF) yields, which are in turn greater than yields on T-bills (BIL). Note also that the steeper the slope of a yield curve, the faster interest rates rise as maturity lengthens. Yield curves are usually upward sloping asymptotically: the longer the maturity, the higher the yield, with diminishing marginal increases (that is, as one moves to the right, the curve flattens out).. Interested readers who wish to study the topic further may wish to refer to the author’s book Analysing and Interpreting the Yield Curve. Similarly, why is the demand curve for labor downward sloping quizlet? The term structure of interest rates refers to the relationship between the yields and maturities of a set of bonds with the same credit rating. Which of the following statements explains the liquidity premium theory of the term structure of interest rates? Yet historically either an upward-sloping or a downward-sloping yield curve held for quite a prolonged period of time. With reference to the data above, what is the exact expected real rate of return on the 2- year Treasury security? An issuer of a bond is more likely to exercise a call option on the bond after. If the 1-year rate today is at 1%, and the 2-year rate is 2% then the one-year rate after one year (1yr forward rate) is around 3% [1.02^2/1.01^1]. Future short-term rates can thus be estimated from the current yield curve. According to the expectations theory, long-term yields are geometric averages of current and expected short-term rates. Question text Suppose a firm wants to take advantage of an upward-sloping yield curve. b. According to the sticky wage theory, the upward slope of the aggregate supply curve in the short-run is due to the fact that nominal wages are slow to adjust to changes in the overall price level (i.e., they are sticky). With reference to the data above, the default risk premium on the 90-day commercial paper above is. A yield curve is typically upward sloping; as the time to maturity increases, so does the associated interest rate. The five basic factors which may explain yield differences include term to maturity, defaultrisk, tax treatment of income of security, marketability, and call, put, or conversion options attached to the security. B) why interest rates on bonds of different maturities tend to move together. C. become upward sloping. This is reflected in the normal yield curve, which slopes upward from left to right on the graph as maturities lengthen and yields rise. In normal conditions, the yield curve is upward-sloping. When the zero curve is downward sloping … The so-called "law of demand" in economics recognizes this, holding that higher prices reduce demand for a good, and vice versa, other factors being equal. If interest rates are expected to increase in the future, one would expect to see an upward sloping yield curve. 12. There are three basic shapes the yield curve can take, each with different implications regarding economic growth. An upward sloping or normal yield curve may indicate that markets expect business-as-usual for the economy, no significant changes in inflation (price rise). Investors will require a lower yield on bond __ and will pay ____ for the bond. Explain how the term structure of interest ratescan be used to help forecast future interest rates. Select one: A. become inverted. For example, an upward sloping yield curve predicts higher short-term rates in the future. Why does the "premium" represent the "expected default loss rate"? The reason is simple – longer the tenor, the riskier it is. 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