Reading 55: Term Structure and Volatility of Interest Rates- class, butterfly, change

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Session 14: Fixed Income: Valuation Concepts
Reading 55: Term Structure and Volatility of Interest Rates

LOS a: Illustrate and explain parallel and nonparallel shifts in the yield curve, a yield curve twist, and a change in the curvature of the yield curve (i.e., a butterfly shift).

 

 

Suppose that there is a nonparallel downward shift in the yield curve. Which of the following best explains this phenomenon?

A) The absolute yield increase is different for some maturities.

B) The absolute yield decrease is different for some maturities.

C) The yield decrease is the same for all maturities.

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A nonparallel downward yield curve shift indicates an unequal yield decrease across all maturities, i.e., some maturity yields declined more than others.

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Suppose the yield curve becomes steeper. Which of the following is a consequence of the steepening?

A) The yield spread between long and short-term securities increases.

B) Long-term bonds become less sensitive to interest rate changes.

C) Long-term bonds become more sensitive to interest rate changes.

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This is by definition. A steepening yield curve means that the slope of the yield curve increases. The slope is the difference (i.e. the term spread) between the yields of two maturities. Consequently, as the yield curve steepens this spread increases.

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A yield curve undergoes a parallel shift. With respect to the bonds described by the yield curve, the shift has least likely changed the:

A) durations.

B) yield spreads for bonds of different maturities.

C) yield to maturities.

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A yield curve is on a graph with interest rates on the vertical axis and maturities on the horizontal axis. A parallel shift of a yield curve means the spread between the interest rates or the “yield spreads” have not changed. The other possible choices to answer the question would change. By definition, the yields to maturity have changed. Since duration changes with changes in yield, all the durations would change.

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Which of the following statements about yield curves is most likely accurate?

A) A negative butterfly means that the yield curve has become less curved.

B) A yield curve gets steeper when spreads widen.

C) A twist refers to changes to the degree to which the yield curve is humped.

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A twist refers to yield curve changes when the slope becomes either flatter or steeper. A negative butterfly means that the yield curve has become more curved.

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Which of the following statements about yield curves is least accurate?

A) A positive butterfly means that the yield curve has become less curved.

B) Twists and butterfly shifts are examples of nonparallel yield curve shifts.

C) The slope of the yield curve changes slightly following a parallel shift.

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The slope of the yield curve never changes following a parallel shift.

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Which of the following is most likely to occur if there is a twist in the yield curve?

A) The curvature of the yield curve increases.

B) The yield curve becomes humped at intermediate maturities.

C) The yield curve flattens or steepens.

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Twists refer to yield curve changes when the slope becomes either flatter or more steep. A flattening (steepening) of the yield curve means that the spread between short- and long-term rates has narrowed (widened).

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With respect to yield curve, a negative butterfly shift means that the yield curve has become:

A) more curved.

B) negatively sloped for all regions.

C) flat.

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By definition, a negative butterfly shift means the curve has become more curved or “humped.” Such a shift could lead to an increase in slope in some regions and a decrease in slope in other regions.

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Suppose that there is a parallel upward shift in the yield curve. Which of the following best explains this phenomenon? The yield:

A) decrease is the same for all maturities.

B) increase is the same for all maturities.

C) increase is proportional to the original level for all maturities.

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Click for Answer and Explanation

A parallel upward shift indicates an equal yield increase across all maturities.

Suppose that there is a parallel upward shift in the yield curve. Which of the following best explains this phenomenon? The yield:

A) decrease is the same for all maturities.

B) increase is the same for all maturities.

C) increase is proportional to the original level for all maturities.

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A parallel upward shift indicates an equal yield increase across all maturities.

 

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A yield curve is flat, and then it undergoes a non-parallel shift. After the shift, which of the following must be least accurate? The new yield curve is:

A) curvilinear.

B) a straight line.

C) flat.

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If a yield curve begins flat and then experiences a non-parallel shift, this means that some rates changed more than others. After the non-parallel shift the formerly flat yield curve can no longer be flat.

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Assuming there is a positive butterfly shift in the yield curve, which of the following statements is most accurate?

A) The curvature of the yield curve increases.

B) The curvature of the yield curve decreases.

C) The yield curve becomes less humped at intermediate maturities.

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A butterfly shift occurs when yields increase (decrease), the yields in the short maturity and long maturity sectors increase more (less) than the yields in the intermediate maturity sector.