Figures for Chapter 8 FORWARD RATES YIELD CURVES

Figures for Chapter 8 FORWARD RATES, YIELD CURVES AND THE TERM STRUCTURE (Investments : Spot and Derivatives Markets) © K. Cuthbertson and D. Nitzsche

Figure 8. 1 : Actual forward-forward agreement Receive $110. 50 f 12 = 10. 5% t=0 t=1 Lend/pay out $100 © K. Cuthbertson and D. Nitzsche t=2 Time

Figure 8. 2 : Synthetic forward (sf 12) Borrow $91. 74 at r 1 = 9% Receive $111 sf 12 = ? r 2 = 10% r 1= 9% t=0 Lend $91. 74 at r 2 = 10% t=1 Repay $100 © K. Cuthbertson and D. Nitzsche t=2 Time

Figure 8. 3 : Synthetic forward rate (sf 12) Difference (year-1) = 10% - 9% = 1% sf 12 = 10% + (10% - 9%) = 2 r 2 - r 1 = 9% sf 12 = 11% r 2 = 10% t=0 t=1 t=2 Time sf 12 plus 1 -year investment at r 1 yields the same dollar amount as the 2 -year investment at r 2. © K. Cuthbertson and D. Nitzsche

Figure 8. 4 : Yield curves Upward sloping yield curve Downward sloping yield curve © K. Cuthbertson and D. Nitzsche

Figure 8. 5 : Yield curve Yield B A 7% 6% 4% B A 1 2 3 Time to maturity If short rates are expected to rise then r 2 = 6% and r 3 = 7%. © K. Cuthbertson and D. Nitzsche

Figure 8. 6 : Liquidity preference Lenders like to lend at short horizon, borrowers like to borrow for long horizon, so long rates contain positive ‘liquidity premia’. Yield Liquidity Preference liquidity premium Expectations hypothesis Time to maturity © K. Cuthbertson and D. Nitzsche