Yield Curve and Growth Forecasts

Q1. Estrella (NY Fed) is quite certain that yield curve is a good predictor of future economic activity.
From the case, or the link to his FAQs, answer the following questions:

a. How successful is the yield curve at predicting recessions?

b. What type of securities and what maturities are best to use?

c. What matters most-the level of the term spread, the change in the spread, or the level of short
rates?

d. Discuss, in the context of a formal model, exactly why a yield curve inversion should lead to a
recession.

Q2. Dick Berner (Morgan Stanley) is a bit more sceptical about the predictive power of the yield
curve. Does he just not understand Estrella’s overwhelming evidence, or does his scepticism rest on
solid reasoning?

Q3. What is Brian Sack’s (then MacroAdvisers, now head of the Markets group at the NY-Fed) take
on the evidence Estrella put forward?

Q4. How is the U.S. yield curve currently sloped? How does this affect your forecast of economic
activity?

Q5. What do you think the yield curve will do over the next 12 months (steepen, flatten, or remain
about the same)? How does this affect your forecast of economic activity?

Salomon and the Treasury Securities Auction

Q1. Based on the information in the case, how serious was the misbehaviour of Mozer and his
group? Who was hurt?

Q2. In June 1991, what actions should Meriwether consider? What are the likely consequesces?

Q3. What should Meriwether do?

Deutsche Bank: Finding Relative Value Trades
Q1. Discuss zero-coupon yield model developed by Deutsche Bank (Exhibit -3), preferably prepare an
excel to explain it with real numbers in Indian Context (you may assume data points if real data is
not available for calibration).

Q2. Based on the output given by the zero coupon yield model (Exhibit-4) spot rates implied by the
coupon paying bonds (Exhibit-1), How would you form your trading strategy? Discuss the expected
risk and return associated with the trading strategy.

Prudential Financial and Asset-Liability Management

Q1. What is a DB Pension? How is it different from a DC Plan?

Q2. Why is ABC engaging in this PRT transaction?

Q3. What is the present value of the pension liabilities of ABC’s DB plan?

Q4. What happens to the present value if the level of interest rates decreases by 1%?

Q5. Qualitatively, how should Prudential construct an investment portfolio to support the pension
liabilities?