chapter 7: learning objectives term structure of interest rates
DESCRIPTION
Chapter 7: Learning Objectives Term Structure of Interest Rates expectations & other hypotheses real interest rate considerationsTRANSCRIPT
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Chapter 7:Learning Objectives
Term Structure of Interest Rates
![Page 2: Chapter 7: Learning Objectives Term Structure of Interest Rates](https://reader035.vdocuments.us/reader035/viewer/2022062302/5a4d1ae07f8b9ab059976c64/html5/thumbnails/2.jpg)
Chapter 7:Learning Objectives
Term Structure of Interest Rates expectations & other hypotheses
![Page 3: Chapter 7: Learning Objectives Term Structure of Interest Rates](https://reader035.vdocuments.us/reader035/viewer/2022062302/5a4d1ae07f8b9ab059976c64/html5/thumbnails/3.jpg)
Chapter 7:Learning Objectives
Term Structure of Interest Rates expectations & other hypotheses real interest rate considerations
![Page 4: Chapter 7: Learning Objectives Term Structure of Interest Rates](https://reader035.vdocuments.us/reader035/viewer/2022062302/5a4d1ae07f8b9ab059976c64/html5/thumbnails/4.jpg)
Chapter 7:Learning Objectives
Term Structure of Interest Rates expectations & other hypotheses real interest rate considerations Anomalies in the yield curve
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Long-term and short-term Government of Canada Bond Yields
0
4
8
12
16
20
24
60 65 70 75 80 85 90 95 00
Long-term yield
Short-term yield
Perce
nt pe
r yea
r
Year
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The Term Structure of Interest Rates: The Expectations Hypothesis
Why hold short-term vs. Long-term bonds? Should their yields be linked to each other?
R1 R2
E11
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The Key Relations in the Expectations Hypothesis
The Simplest case: R2 = (R1 + E11)/2
The General case: Rn = (R1 + E11 + E2
1 + … + En-11)/n
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The Expectations Hypothesis: Two Examples
R2 5=(4+6)/2R1 4 14E1
1 6 13E1
2 12.5E1
3 12E1
4 11.5R5 12.6=(14+13
+12.5+12+11.5)/5
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Hypothetical Yield Curves
Term
Yield
Rising
Constant
Falling
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Financial Focus 7.1
Hypothetical YC are an estimate of the relationship between yield and term to maturity
Term
Yield
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Financial Focus 7.1
Hypothetical YC are an estimate of the relationship between yield and term to maturity
Yield curves must be constructed for similar types of financial instruments
Term
Yield
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Financial Focus 7.1
Hypothetical YC are an estimate of the relationship between yield and term to maturity
Yield curves must be constructed for similar types of financial instruments
One must not read too much into the shape/slope of a yield curve
Term
Yield
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Yield Curve Puzzles
The Yield curve is generally upward sloping
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Yield Curve Puzzles
The Yield curve is generally upward sloping Table 7.3 shows that the term premium is
generally positive
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Table 7.3: Yield differential relative to 90-day treasury bills
(1)Decades
(2)1 to 3 Years
(3)3 to 5 Years
(4)5 to 10 Years
(5)10 Year and Longer
(6)% of Quarters Spread is
Positive1960’s 0.513 0.877 1.090 1.255 92.51970’s 0.442 0.766 1.046 1.531 90.01980’s 0.044 0.096 0.184 0.455 65.01990’s 0.544 0.876 1.212 1.606 87.0
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Yield Curve Puzzles
The Yield curve is generally upward sloping Table 7.3 shows that the term premium is
generally positive The yield curve tends to shift over time
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Yield Curve Puzzles
The Yield curve is generally upward sloping Table 7.3 shows that the term premium is
generally positive The yield curve tends to shift over time
Figure 7.3 shows that inflation tends to shift the entire yield curve
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Shifting Yield Curves
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Yield Curve Puzzles
The Yield curve is generally upward sloping Table 7.3 shows that the term premium is generally
positive The yield curve tends to shift over time
Figure 7.3 shows that inflation tends to shift the entire yield curve
The slope of the yield curve tends to predict future economic activity
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Yield Curves and Monetary Policy
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Figure 7.4: Shifting yield curves
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Figure 7.5: The yield spread and recessions in Canada
-4
-3
-2
-1
0
1
2
3
4
5
1960 1965 1970 1975 1980 1985 1990 1995 2000
Yield
Spr
ead
Year
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POINT-COUNTERPOINT 7.1: The Information Content in Yield Curves
POINT: COUNTERPOINT:
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POINT-COUNTERPOINT 7.1: The Information Content in Yield Curves
POINT: The YC is easy to
understand
COUNTERPOINT:
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POINT-COUNTERPOINT 7.1: The Information Content in Yield Curves
POINT: The YC is easy to
understand At maturities of <= 3
yrs inflation forecasting performance is good
COUNTERPOINT:
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POINT-COUNTERPOINT 7.1: The Information Content in Yield Curves
POINT: The YC is easy to
understand At maturities of <= 3
yrs inflation forecasting performance is good
Useful pedagogical device to understanding central bank policies
COUNTERPOINT:
![Page 27: Chapter 7: Learning Objectives Term Structure of Interest Rates](https://reader035.vdocuments.us/reader035/viewer/2022062302/5a4d1ae07f8b9ab059976c64/html5/thumbnails/27.jpg)
POINT-COUNTERPOINT 7.1: The Information Content in Yield Curves
POINT: The YC is easy to
understand At maturities of <= 3
yrs inflation forecasting performance is good
Useful pedagogical device to understanding central bank policies
Helps to understand debt management
COUNTERPOINT:
![Page 28: Chapter 7: Learning Objectives Term Structure of Interest Rates](https://reader035.vdocuments.us/reader035/viewer/2022062302/5a4d1ae07f8b9ab059976c64/html5/thumbnails/28.jpg)
POINT-COUNTERPOINT 7.1: The Information Content in Yield Curves
POINT: The YC is easy to
understand At maturities of <= 3
yrs inflation forecasting performance is good
Useful pedagogical device to understanding central bank policies
Helps to understand debt management
COUNTERPOINT: LT and ST bonds are
not good substitutes
![Page 29: Chapter 7: Learning Objectives Term Structure of Interest Rates](https://reader035.vdocuments.us/reader035/viewer/2022062302/5a4d1ae07f8b9ab059976c64/html5/thumbnails/29.jpg)
POINT-COUNTERPOINT 7.1: The Information Content in Yield Curves
POINT: The YC is easy to
understand At maturities of <= 3
yrs inflation forecasting performance is good
Useful pedagogical device to understanding central bank policies
Helps to understand debt management
COUNTERPOINT: LT and ST bonds are
not good substitutes Transactions costs
can be significant
![Page 30: Chapter 7: Learning Objectives Term Structure of Interest Rates](https://reader035.vdocuments.us/reader035/viewer/2022062302/5a4d1ae07f8b9ab059976c64/html5/thumbnails/30.jpg)
POINT-COUNTERPOINT 7.1: The Information Content in Yield Curves
POINT: The YC is easy to
understand At maturities of <= 3
yrs inflation forecasting performance is good
Useful pedagogical device to understanding central bank policies
Helps to understand debt management
COUNTERPOINT: LT and ST bonds are
not good substitutes Transactions costs
can be significant Empirical evidence for
EH weakest for US
![Page 31: Chapter 7: Learning Objectives Term Structure of Interest Rates](https://reader035.vdocuments.us/reader035/viewer/2022062302/5a4d1ae07f8b9ab059976c64/html5/thumbnails/31.jpg)
POINT-COUNTERPOINT 7.1: The Information Content in Yield Curves
POINT: The YC is easy to
understand At maturities of <= 3
yrs inflation forecasting performance is good
Useful pedagogical device to understanding central bank policies
Helps to understand debt management
COUNTERPOINT: LT and ST bonds are
not good substitutes Transactions costs
can be significant Empirical evidence for
EH weakest for US Ignores many other
factors that determine yields over time
![Page 32: Chapter 7: Learning Objectives Term Structure of Interest Rates](https://reader035.vdocuments.us/reader035/viewer/2022062302/5a4d1ae07f8b9ab059976c64/html5/thumbnails/32.jpg)
Competing Explanations of the Term Structure
The Liquidity Premium theory: Holding longer term bonds in inherently riskier because the market is thinner
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LIQUIDITY PREMIUM
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Competing Explanations of the Term Structure
The Liquidity Premium theory: Holding longer term bonds in inherently riskier because the market is thinner
The Market Segmentation theory: Short-term and long-term markets are separate
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MARKET SEGMENTATION
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Competing Explanations of the Term Structure
The Liquidity Premium theory: Holding longer term bonds in inherently riskier because the market is thinner
The Market Segmentation theory: Short-term and long-term markets are separate
The Preferred-Habitat theory: there is limited substitutability between short-term and long-term bonds
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Figure 7.7: Interest rates and the maturity structure of government of Canada debt
3
4
5
6
7
8
0
4
8
12
16
20
1980 1985 1990 1995 2000
Aver
age m
atur
ity
Year
Treasury bill
Long term bonds
Averagematurityof debt
Percent per year
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Summary
The term structure of interest rates explains why interest rates differ when their term to maturity differs
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Summary
The term structure of interest rates explains why interest rates differ when their term to maturity differs
The expectations hypothesis predicts that long term rates are averages of expected short-term rates
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Summary
The term structure of interest rates explains why interest rates differ when their term to maturity differs
The expectations hypothesis predicts that long term rates are averages of expected short-term rates
Despite the appeal of the expectations hypothesis there are “puzzles” in the behaviour of the yield curve