Essay About Yield Curve And Longer Maturity Years Bonds

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[pic 1]Figure 1.1: Yield Curve on 15/03/2012Explanation:From yield curve above, we can found that the yield curve is upward sloping and the longer the maturity dates, the higher the interest rate is. The extra compensation which is maturity risk premium must be given to those investors to attract them to hold the bond for a longer period. We also know that many investors are willing to hold the longer maturity years bonds are because it has a higher interest rate. This is due to investors ask for short- term investment to lower down the risk and high liquidity while issuer company ask for long- term investment to have sufficient fund to finance their long- term projects and low liquidity. 2. The Face Value of the bond is assumed as $1000BondABCDYears1234Face Value1000100010001000Yield to Maturity (YTM)0.2715%0.4128%0.6273%0.8366%Market Price (USD)997.292991.795981.415967.224Portfolio X3- year zero coupon bond: $981.42 x 5 = $4907.104- year zero coupon bond: $967.22 x 5 = $4836.10                                                                  $9743.20 *(1)Portfolio Y1-year zero coupon rate: $997.29×2              = $1994.582-year zero coupon rate: $991.42×7.82 *(3) = $7748.62 *(2)                                                                     $9743.20Working (1): $4907.10 + $4836.10 = $9743.20Working (2): $9743.20 – $1994.58 = $7748.62Working (3): $7752.90 ÷ $991.42= 7.82 (copies)In the Portfolio X, there are 3- year bond and 4- year bond is available. The total amount used to purchase 3- year zero coupon bonds and 4- year zero coupon bonds are $9743.20. While $9743.2 is only able to purchase 2 copies of 1- year zero coupon bond and 7.82 copies of 2- year zero coupon bond. From the situation above, we can found that it’s able to purchase more copies of bond in portfolio Y than portfolio X with the amount of $9743.20 due to price of bond in portfolio X is higher than portfolio Y. The bond price of portfolio Y is higher due to the maturity date is shorter and the risk bear by the investors is lower, in the same time the yield to maturity will be lower too. While the bond price of portfolio X is lower due to the maturity date is longer and the risk bear by the investors is higher, in the same time the yield to maturity will be higher too.