Name : Sumon Baul

ID : 181006057

Assignment

Soluation -1

Answer the yield curve is primarily influenced by interest rate expectations.

Would the yield curve the upward sloping or downward sloping? Why?

Market expects that the economy would perform better over coming up. As a result there would be
more demand for funds from various participants in the market. If there is more demand for firms,
interest rates would go up.
Shape of the yield curve dependent on a host of factors. This includes future expectations of interest
rates. Liquidity premium expected for holding long term investments. Investor preferences, demand and
supply of funds and wider economic condition. all the factors interact to give rise to the shape of the
yield curve.

The term structure of interest rates can be explained by three theories. The pure expectations theory
suggests that the shape of the yield curve is dictated by interest rate expectations. The liquidity
premium theory suggests that securities with shorter maturities have greater liquidity and therefore
should not have to offer as high a yield as securities with longer terms to maturity. The segmented
markets theory suggests that investors and borrowers have different needs that cause the demand and
supply conditions to vary across different maturities; in other words, there is a segmented market for
each term to maturity, which causes yields to vary among these maturity markets. Consolidating the
theories suggests that the term structure of interest rates depends on interest rate
expectations, investor preferences for liquidity, and the unique needs of investors and borrowers in
each maturity market.

If the interest rate is expected to be higher in future, people may prefer to park their funds in short term
investments. The prices of short term investment rise and lead to fall in yield at short-term maturity.
Yield curve would become upward-sloping and the reverse situation would make the yield curve
downward sloping.
Soluation-2
Answer that as of today, the annualized two-year interest rate is 13%, while the one-year
interest rate is 12%. Use only this information to estimate the one-year forward rate.

t+ 1= –1

= –2

= 0. 1401

= 14.01

Soluation-3

If the interest rates are solely influenced by expatiations of future interest

Rates, then explain the following relationship:

a) t+1r1 > ti1 {=What will be the shape of the yield curve? =What will be the future interest

rate than today’s rate}

b) t+1r1 = ti1 {=What will be the shape of the yield curve? =What will be the future interest

rate than today’s rate}

c) t+1r1 <ti1 {=What will be the shape of the yield curve? =What will be the future interest

rate than today’s rate}

SCENARIO STRUCTURE OF YIELD CURVE EXPECTATIONS ABOUT THE

FUTURE INTEREST RATE

t+1r1 > ti1 Upward slope Higher than today’s rate

t+1r1 = ti1 Flat Same as today’s rate

t+1r1 <ti1 Upward slope Lower than today’s rate