National Bureau of Money and Banking †Free Samples to Students

Question: Discuss about the National Bureau of Money and Banking. Answer: Introduction: The three main attributes of the yield curve i.e. level, steepness and curvature affects the fixed income instruments in the long run. The rate of interest is affected by various common factors. These three factors are responsible for 95% variation in the yield curve. There is a direct relation between the volatility in the interest rate and the shape of the yield curve. The curvature of the yield curve is described as butterfly portfolio and it carries a long position in the maturity of the bond. The slope of the yield curve depends on the future changes in risk premium as well as interest rate in the short run. The slope of curvature may vary as there is volatility in the short run across different time periods. In certain cases, the curvature and the slope of the yield curve depends on the rate of volatility in the short run. (Litterman and Scheinkman 1991). When the yield curve is steeper, there is higher interest rate volatility. If the economy experiences level shock", there wi ll be change in the maturity by the same amount. This will change the level of the yield curve. Moreover, if the economy experiences shock in the "slope", it will increase the interest rate in the short term by a larger amount than in the long run. The yield curve will become less steep and the slope of the yield curve decreases. If the economy experiences shock in the "curvature", it will affect the medium term interest rates and the yield curve will become hump shaped. The steepness factor does not correspond to the normal changes as in the case of normal steep curve but it is the main factor which affects the interest rate to a large extent than the other factors (Chen and Tsang 2013). The yield curve depicts the yield of the U.S. treasury bills, bonds, notes in systematic order from short term maturity to long term maturity. The slope of the yield curve reflects the short term interest rate of the bond market. It gives a reflection of the various kinds of economic activities and the level of inflation in the near future. It is very important to analyze the slope of the yield curve. In case of Australia and Netherland, it can be seen that the shape of the curve is upward rising i.e. it is moving from left to right. This upward rising slope indicates that the yields from bond increases with maturity. The upward rising shape of the yield curve is seen under normal circumstances. In such a case, the investors believes that there are no important changes in the economy i.e. any inflationary condition will not affect the economy and the economy will grow at a normal rate. In such a situation, the investors will accept higher amount of yield for the income instruments wi th longer maturity rates. The long term income securities will thus bear higher yield than the short term securities. Sometimes, the yield curve also slopes downward. (Chinn and Kucko 2015). There is also a case of flattening of the yield curve in both the economies and this happens when the short term rates are increasing at a much faster rate than the long term rates. This indicates that the economy of both the countries is growing at a much slower rate and the investors are at a riskier position. The yield curve also helps in predicting the recession in an economy. The recessions in both the economies may also lead to an inverted yield curve. Thus, it can be said that the yield curve can help in the financial decisions in the economy (Greenwood, Hanson and Vayanos 2015). Reference List Chen, Y.C. and Tsang, K.P., 2013. What does the yield curve tell us about exchange rate predictability?.Review of Economics and Statistics,95(1), pp.185-205. Chinn, M. and Kucko, K., 2015. The predictive power of the yield curve across countries and time.International Finance,18(2), pp.129-156. Greenwood, R., Hanson, S. and Vayanos, D., 2015.Forward guidance in the yield curve: short rates versus bond supply(No. w21750). National Bureau of Economic Research. Litterman, R.B. and Scheinkman, J., 1991. Common factors affecting bond returns.The Journal of Fixed Income,1(1), pp.54-61.