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LECTURE 3 QUESTIONS

# LECTURE 3 QUESTIONS - Lecture 3 Questions 1 What do the...

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Lecture 3 Questions 1. What do the different shapes of the yield curve mean? Please draw graphs. Answer: Rising Yield Curve (upward sloping): Expect future short rates to be higher than current levels. Falling Yield Curve (inverted or downward sloping): Expect decline in future short rates. Hump-Backed Yield Curve: Expect that future short rates will first rise and then fall. Flat Yield Curve: Expect the future short rates to stay constant. The graphs should be in your notes. 2. a) Calculate the forward rate for a one-period loan to be made 7 periods from now if yield_7=6% and yield_6=4%? Answer: You were supposed to use the f y y n n n n n = + + - - - ( ) ( ) 1 1 1 1 1 formula in your lecture 3 notes. If you plug in n=7, then you’ll get the forward rate=0.189. b) Calculate the forward rate for a four-period loan that matures at time 9 if yield_9=6% and yield_5=4%? Answer: You were supposed to use the x n x x n x n n n f y y ) 1 ( ) 1 ( ) 1 ( + + = + - - formula in your lecture 3 notes.

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If you plug in 4 instead of x, 9 instead of n, and 5 instead of n-x in the above formula then you’ll get the forward rate=0.086.
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