Professional Custom Accounting: What are some ways financial market participants use the yield curve to make decisions?
1) The annualized interest rate on a three-year security today is 9 percent, and the annualized interest rate on a two-year security is 7 percent. Estimate the one-year forward rate two years from now.
2) Two investment alternatives are presented to you, and you can only choose one: 1) invest in a one-year municipal bond with a 5 percent yield or, 2) a one-year corporate bond with an 8 percent yield. Your applicable federal income tax rate is 28 percent and no other differences exist between these two securities, which one would you invest in?
3) Interest rates for one-year securities are expected to be 4 percent today, 7 percent one year from now and 8 percent two years from now. Considering the pure expectations theory covered in the textbook, what are the current interest rates on two-year and three-year securities?
4) Based on material in the textbook, what are some factors that influence the shape of the yield curve? What are some ways financial market participants use the yield curve to make decisions?
5) Analysts predict there will is an expectation of increasing interest rates in the future. What would be the effect on the shape of the yield curve? Explain.
