Question

The Federal Reserve, in recent years, has imparted on a new path to support the financial...

The Federal Reserve, in recent years, has imparted on a new path to support the financial recovery and economic expansion of the United States. In the wake of the 2008 financial crisis, the Fed, in a move that at the time was unprecedented, absorbed trillions of dollars in "toxic" assets to calm investors, inject liquidity, and thaw credit markets. At the outbreak of the COVID-19 epidemic in March of 2020, the Fed pledges yet another unprecedented measure of support, swelling the Fed’s balance sheet to over seven trillion dollars. Investors now begin to face the dual financial headwinds of interest rates rising beyond the ability of the Federal Reserve to control, or even the prospect of negative interest rates in the future.

In response, investors are devising their own analysis and expectations as to what they believe will happen over the next several years. With this in mind, please answer the following questions:

  • What is the U.S. treasury yield curve? What information does it provide to investors? What makes the U.S. treasury yield curve so foundational to capital markets?
  • Explain the relationship between interest rates, bond prices, and stock prices. Why, all things remaining equal, do equities tend to fall as interest rates rise? Why does bond price behavior move opposite to interest rate behavior?
  • Why would a bond sell at a discount? What does this have to do with the behavior of interest rates over time?
  • Bonds have the reputation of being “safer”, or more conservative investments. Do you agree with that assessment? Why, or why not?

Homework Answers

Answer #1

Treasury Yield Curve and overall its behavior :

It is total amount of earning from investment like U.S. bond, treasury bill and inflation-protected securities. The demand and supply of mechanism decides the price of security. U.S. treasury department conducts the auction to sets fix face value and interest. It is safest beacuse they are regulated by U.S. government as compared to other bonds. If the secondary market interest rate raise then government has to pay higher rate of interest on securities. Buyers cannot hold on securities and they may sell them in secondary market.

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