EQUITY VALUATION MEASURE
What can they tell us?
Describe in your own words what a yield curve is and what the impact is of a central bank’s monetary policy.
A yield curve is a curve which represents graphically the interest rate of same quality of credit bond related to a precise moment. The point is that those bonds have not the same date of maturity (long-term and short-termrates). The yield curve represents the price of what we can call “the price of liquidity renunciation”. The more the renunciation is on a long period (for an example a long-term bond); the more the interest rate is high. That means that the bond given by companies or states on long period (like 10, 20, or 30 years) must offer higher remuneration than the ones proposed by bank placements or short-termplacements (less than one year) to be attractive. In fact, the investor will not get its money back for a long time in the case of long-term bonds, and they may want some advantages not to have this money as liquidity for such a long time. The difference between bond’s interest rates is due to the fact that bonds have different credit risks, liquidity, and taxation. The one which is most used isthe treasury dept. It is used as a reference to compare other rates in the market, notably mortgages or banks’ ones. It is also used to analyze and anticipate upcoming changes that are going to affect directly the economy.
What is the yield curve and what does it tell us?
Yield curve evolutes with a referent long-term rate (state bond for example) and a referent short-term rate on themonetary market. The curve is the spread between those two rates. This spread depends a lot on time, as a 30-year bond is taken in account until its date of payment. I
The yield curve is a lot analyze because its evolution allows giving an idea of future interests’ rate change, inflation and economic evolution. Then an augmentation of the credit risk makes the curve rise because investors must havecompensations for the supplementary risks they take. In a same way, an augmentation of liquidity makes the curve go down because investors have fewer costs to pay. Finally if taxation grows up, the yield curve will go up because investors must have compensations because they will have to pay more taxes. So, as we just saw, there are two main shapes of yield curve. The first case as we say before iswhen the curve goes up: this means that demand and offer prefer both a precise term. As the yield curve represents the balance between bond’s offer and demand on each bond market (which are separated depending on their date of payment), the short-term bond demand is more important than the long-term bond when the yield curve goes up. The second case is when the curve goes down: it means thatthe bond’s offer and demand consider both that different bonds’ terms are the same so can be commuted. In fact, for them, it’s the same to buy a tow-year bond than to buy a one-year bond, and buy another one a year later.
Yield curve is in some countries (as France and United States) an indicator of a brake or an acceleration of the economy. The fact that the spread between long-term andshort-term rates is that preferences for short-term or long-term investments are really variable too. In some periods, long-term bonds would be preferred and some period this preference is inversed, and that can inverse the curve. This is what central banks study and try to adjust inexorably. That’s what we are going to see in the next step.
The impact of the yield curve on central banks’ monetary policyIn countries where monetary policy is not managed by a fix change idea, short-term rates come from investors of central banks on the monetary market. Actually, when production is high so when demand is higher than offer Central Banks rise short-term rates first because companies need a lot of money and prefer to borrow a lot at low rates. So, Central Banks want, with rising long-term rates, to...
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