Buy a cheap copy of Essentials of Investments book by Zvi Bodie. The market leading Essentials of Investments, 6e by Bodie, Kane and Marcus is an undergraduate textbook on investment analysis, presenting the practical. Free shipping over $10.
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9 Bond Prices and Yields 323PercentPercentPercentPercent6.506.50 8.60 9.008.406.258.606.008.206.008.205.508.005.77.807.805.005.507.407.604.507.43 5 3010 3457345710 30MonthsYearYearMonthsMaturitiesFalling yield curveFIGURE 9.11The Expectations TheorySuppose everyone in the market believes firmly that while the current one-year interest rate is8%, the interest rate on one-year bonds next year will rise to 10%. What would this belief im-ply about the proper yield to maturity on two-year bonds issued today?It is easy to see that an investor who buys the one-year bond and rolls the proceeds into an-other one-year bond in the following year will earn, on average, about 9% per year.
This valueWEBMASTERTerm Structure of Interest RatesThe bond section of the Smart Money website has a section called the Living Yield Cur ve.It has a graph that allows you to compare the shape of the yield curve at different pointsin time. Go to Smart Moneys website at yieldcur ve. Then, use the site to answer the following questions:1. What is consider ed a normal yield cur ve?2. Compare the yield cur ve for December 2001 with the average yield cur ve.According to their explanations what would the market be expecting with a steepupward sloping yield cur ve?3. What type of yield curve was present in March 1980?
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How does that cur vecompar e with the typical yield curve?324 Part THREE Debt Securitiesis just the average of the 8% earned this year and the 10% expected for next year. More pre-cisely, the investment will grow by a factor of 1.08 in the first year and 1.10 in the secondyear, for a total two-year growth factor of 1.08 1.10 1.188. This corresponds to an annualgrowth rate of 8.995% (because 1.089952 1.188).For investments in two-year bonds to be competitive with the strategy of rolling over one-year bonds, these two-year bonds also must offer an average annual return of 8.995% over thetwo-year holding period. This is illustrated in Figure 9.12. The current short-term rate of 8%and the expected value of next years short-term rate are depicted above the time line.
Thetwo-year rate that provides the same expected two-year total return is below the time line.
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