There are three factors that can affect the shape of the Treasury yield curve (\

Question

There are three factors that can affect the shape of the Treasury yield curve (', IPt, and MRP) and five factors that can affect the shape of the corporate yield aurve (t, IPt, MRPt, DRPt, and LP). The yield curve reflects the aggregation of the impacts from these factors Suppose the real risk-free rate and inflation rate are expected to remain at their current levels throughout the foreseeable future. Consider all factors that affect the yield curve. Then identify which of the following shapes that the U.S. Treasury yied curve can take. Check all that apply. Inverted yied curve Downward-sloping yield aurve Upward-sloping yield aurve ldentify whether each of the following statements is true or false Statements True False If inflation is expected to decrease in the future and the real rate is expected to remain steady, then the Treasury yield curve is downward sloping. (Assume MRP0.) All else equal, the yieid on new bonds issued by a leveraged firm will be less than the yield on the new bonds issued by an unleveraged firm The yied curve for a 888-rated corporate bond is expected to be above the U.S. Treasury bond yield curve. Yield curves of highly liquid assets will be lower than yield curves of relatively iliquid A U.S. Treasury yield curve is plotted in the following graph: INTEREST RATE 1%! esc 2 3

Explanation / Answer

1) since treasury bond yield if measured by:

T-bond yield = r*t + IPt + MRPt

and since MRP increases with maturity ,

the only correct option is

upward sloping yield curve

2)

a) statement 1 is True

since as we saw above if MRP is zero and real rate is expected to remain steady , the treasury yield curve will depend only on inflation premium which will decrease if inflation decreases.

b) statement 2 is False

this is because when a leveraged firm will add more debt to its capital structure , the risk of default will be more relative to a an unlevereaged firm issuing debt for the first time . To compensate investors for the increased risk , a leveraged firm will have to offer a higher yield on the debt than an unlevered firm

c) statement 3 is True

since a corporate bond will always have a higher risk of default than a treasury bond, its DRP will be > 0 . Hence the yield on corporate bonds will be greater than that for a treasury bond

d) statement 4 is true

this is because a highly liquid asset will have less liquidity risk and hence a lower liquidity premium. Thus the yield curve of a liquid asset is lower than that of an illiquid asset

3)

The correct statement is if pure expectations theory is correct, future short term rates are expected to be higher than current short term rates

this is because

The 2nd statement is false since the Pure expectations theory does not depend on the yield curve being either upward or downward sloping.

The 3rd statement and 4th statement can both be true at the same time and hence we cannot choose only one of them

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.