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Return on Financial Assets

In: Business and Management

Submitted By llopez704
Words 713
Pages 3
1. List the bonds in the order of its interest rate (yields to maturity) from highest to lowest. Explain your work.
The order, highest to lowest, is: X, W, Y and Z
Bonds with higher ratings are considered to be the most stable and least likely to default, therefore considered to be a lower risk. The lower the risk associated with the bond, the lower the interest rate/yield to maturity. In other words, corporate bond ratings have a reverse impact on their interest rate. So, the lower rated BBB bond will have higher interest rate than the AAA bond.
Short-term interest rates are typically lower than long-term interest rates. The longer you are vested in a bond or security, they greater the yield is expected to be, thus Y is lower than X and W.
A market that is more liquid allows for more flexibility for the investor enabling them to trade at lower costs creating an even lower risk for the investor. In order to attract investors into less liquid markets, the interest rate must be higher and worth the investment. Thus the yield to maturity is even lower on Z, than all others.
2. Explain how an economist could use the slope of the yield curve to analyze the probability that a recession will occur and why the spread may matter.
The shape of the yield curve represents what the interest rates look like against the time to maturity. When the economy is in a generally “good” state, the shape of the yield curve will slope slightly upward. This shape is a representation that as length of maturity increases, so does the interest rate. Investors would expect a greater return for investing their funds for a longer term.
Prior to a recession, however, the slope of the curve becomes inverted. This downward slope means that the interest rates are higher for shorter term bonds than long term, giving an indication of a slowing economy. Investors will settle for lower

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