Question

Assumed the Treasury security yields for today are as follows:

* 3 month T-bills       4.50%

* 6 month T-bills       4.75%

* 1 yr T-notes         5.00%

* 2 yr T-notes            5.25%

* 3 yr T-notes            5.50%

* 5 yr T-bonds           5.75%

* 10 yr T-bonds         6.00%

* 30 yr T-bonds         6.50%

Draw a yield curve based on this data. Discuss the implication if you are: a) Borrower and b) Lender.

Answer 1

0% 5% 4% 3% 2% 196 096 10 15 20 25 35 Borrowing period (in years)

This is a normal yield curve with rates on long-term bonds increasing. This implies that borrowers expect long-term bonds to have more risk than short-term bonds which is an indication that the economy is supposed to grow normally without any major changes in inflation or any disruption in available credit. Similarly, for lenders, this yield curve implies that long-term bonds will be riskier than short-term bonds and so, will be issued at higher required rates of return.