Economics of Money, Banking and Financial Markets 4
NAME:________________________________
Econ 444: Bunting
CW4: Risk, Term Structure
Answer the questions @ 2 points, showing work
1. Risk premiums on corporate bonds are usually anticyclical; that is, they decrease during business cycle expansions and increase during recessions. Use diagrams to show why is this so.
2. Predict what will happen to interest rates on a corporation’s bonds if the federal government guarantees today that it will pay creditors if the corporation goes bankrupt in the future. Use diagrams to show what will happen to the interest rates on Treasury securities.
4. If a yield curve looks like the one shown in the figure below, what is the market predicting about the movement of future short-term interest rates? What might the yield curve indicate about the market’s predictions for the inflation rate in the future?
5. Find the expectations yield curve given the following:
|
Year |
Expected One-Year Bond Rate |
Term (Liquidity) Premium |
Expected Future Rate |
|
1 |
3% |
0 |
|
|
2 |
5% |
0.2% |
|
|
3 |
5.5% |
0.3% |
|
|
4 |
7 |
0.7% |
|
|
5 |
9% |
1.2% |
|
6. If a yield curve looks like the one shown in the figure below, what is the market predicting about the movement of future short-term interest rates? What might the yield curve indicate about the market’s predictions for the inflation rate in the future?
7 The table below shows current and expected future one-year interest rates, as well as current interest rates on multiyear bonds. Use the table to calculate the liquidity premium for each multiyear bond. (use blank columns for answers)
|
Year |
One-Year Bond Rate |
Multiyear Bond Rate |
|
|
|
|
1 |
2% |
2% |
|
|
|
|
2 |
3% |
3% |
|
|
|
|
3 |
4% |
5% |
|
|
|
|
4 |
6% |
6% |
|
|
|
|
5 |
7% |
8% |
|
|
|
3