GRAPHS (40 pts) 1) Below you can find the yield curves for four different dates
ID: 2783658 • Letter: G
Question
GRAPHS (40 pts) 1) Below you can find the yield curves for four different dates for the Turkish econom 10,2 10.0 9.8 9,6 9,2 90 8.8 8,6 2Y SY BY a) Explain the situation for 31/12/2015, which is shown by curve #4 in the graph. What can you say about the slope of the yield curve for that date? What do investors think? (8 pts) b) The yield curves #1,2,3 have strictly upward sloping yield curves. What does that tell you about the expected future real interest rates regarding these yield curves? (8 pts) c) As you can see from the graph, there is a downward shift from curve #4 to other curves. What does that tell you about the perceptions of the investors in the economy? (8 pts)Explanation / Answer
Yield curve is the curve between the interest rates or yield of bonds with different time to maturity but of similar credit quality. In an yield curve, on the X-axis is the time to maturity and on the Y-axis is the yield.
a) On 31/12/2015, the yield curve is inverted, and then flattened and finally normal yield curve. The slope indicates that the interest rate of bonds falls slightly from 2 year bonds to 3 year bonds. Then it stays constant till 9 year bonds and then rises again for the 10 year bonds. Generally an investor expects that as he/she is investing his/her money in a bond for a longer time period, so the interest that he/she will receive will also be high. But in this case, the yield curve shows that there is small difference between the long term and short term bonds. Investors believe that the economy is not in a good condition. They are not very hopeful about the future of Turkish economy.
b) The yield curves 1, 2 and 3 are upward sloping. This implies that the future real interest rates are expected to rise. As the yield curves are upward sloping, the long term bonds give more interest than the short term bonds. High interest rates are expected by the investors as they believe that they should be compensated for taking the additional risk of investing in a long term bond. So, an additional risk premium has to be paid for holding the bond for a long time period.
c) The downward shift from curve 4 to the other curves shows that on 31/12/2015, the economic condition of the Turkish economy was bad. Curve 4 is an indication of economic weakness and it can be expected that there is a upcoming recession. However, towards the end the yield curve becomes normal. It can be said that the period after 31/12/2015 was a period of economic recession. So the interest rates fell and hence the interest rates from 31/08/2016 are 8.8 percent. After 31/08/2016 the interest rates of the bonds have been rising and the yield curve is normal with an upward slope. This is a signal of economic strength. It indicates that the future of the Turkish economy is improving.
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