Book 7, Exam 3, Q.s 47 & 48. WTF! butterfly, structure, current

MiniMe7

So we are given these rates
Last Year: 2.5% (1 year), 4.5% (5 year), 7% (10 year), and 12% (20 year)
Current: 2.5% (1 year), 8% (5 year),11.5% (10 year), and 12% (20 year)
47. Asks how liquidity theory best explains the CURRENT curve
The answer is that the curve is humped (okay yea sure negative butterfly and all) with a NEGATIVE SLOPE AT THE LONG END OF THE CURVE!
Can someone please explain to me where these Schweser SHITHEADS learned to take a derivative the current term structure is monotonically increasing throughout the entire maturity range, where the hell do they find a negative slope at the long end of the curve?
48. Ask how preferred habitat theory best explains the prior years curve
The answer states that the prior years curve is flat, but excess demand from ST investors and excess supply of LT loanable funds has created an upward sloping curve.
Again can someone explain to me how last years curve is flat? Clearly it is not! It is also monotonically increasing in maturity. Furthermore, an excess supply of LT loanable funds is likely to push down the LT rates just as the excess demand of ST investors pushes down ST rates.
I mean WTF are these ASSCLOWNS doing? Granted the answers I chose weren’t fully correct either, but at least I know what a FUCKING slope is!

himanshumh

Damn no one still has any idea on either of these?

JonnyKay

Anyone got any ideas?

JRossSter

Obviously I have not done a good job. Maybe somebody can explain it in a better way. The spot rate is whatever the security is trading for today. It would seem to me that that would mean that is the total rate with all the premium/discounts included for someone to buy/sell on. It’s the current price/rate today.
Looking from this direction, the answers make sense, backwards induction. Can somebody come up with a diff way to make the answer match the data given?

JRossSter

@Nep-hi: okay now we may be getting somewhere
You state that “They want to know the underlying curve rates, you have to strip way the premiums. The rates they gave you include both the real interest rates and the premiums for liquidity/preference.” However the figure with the rates given in the question is clearly labeled as the current and prior year SPOT RATE CURVE (this means we can use these rates to construct a curve). The questions go on to ask “…which of the following statements best explains the current/prior year SPOT RATE CURVE.” Note it refers particularly to the spot rates that are given and that can be used to construct the sport rate curve which the question is subsequently asking you to analyze, not the “real rates” that you refer to as the rates given less the included premiums! This argument is crucial for everything that follows for obvious reasons.
You say “You have to look at the underlying premium for the liquidity risk” how? I don’t know what this risk premium is.
Also you say “The spread is where they are coming up with the negative slope at the tail.” The spread over what?
For Q47 you say “. The liquidity premium will be higher for longer term maturities. This means the real interest rate had to go down” why did it have to go down? The one year rate a year ago and the one year rate today are the same, if anything that tells me that the 1 year liquidity premium for both has stayed the same.
For Q48 see my first reference to your comments above where I talk about the spot rate curve, and not the “real rate” curve that you mention. Where do you find/see or how do you conclude that all real rates are the same as last year? This seems like a somewhat unreasonable assumption.
Looking forward to the discussion

Daniel1985

They want to know the underlying curve rates, you have to strip way the premiums. The rates they gave you include both the real interest rates and the premiums for liquidity/preference.
You have to look at the underlying premium for the liquidity risk. The spread is where they are coming up with the negative slope at the tail.
47. Time has passed but yet the rates last year and this year are the same. The liquidity premium will be higher for longer term maturities. This means the real interest rate had to go down, the higher liquidity premium was added to make the final quote the same both year.
48. All real rates are the same last year, with buyers needing/wanting to be in certain spaces of the maturity curve, so the premium is high/low based on the maturity preference. The curve can still be flat.
hope it helps some..

Daniel1985

I know you didnt say you were better than scwheser, didnt mean it like that.. but if you can pull out something that intricate in a detail of the answer, i believe you will be good to go. Many questions we come across each day are BS.. sometimes it is better to let them go..
but if anyone knows the answer go on in your quest for knowledge..

dyga

@CFA: never said I am better than Schweser just that I know the definition of slope and they apparently don’t. But my concern with crap like this is that its just going to confuse the true CFA concepts with their interpretation (felt like this on some question on L1), as I have come into numerous examples of Schweser either conflicting with itself and/or the CFAI.
Anyway, onto the real matter at hand. Anyone have any ideas on the answers to these two?

ramdabom

I was totally confused by this one as well.
I think I wrote a topic asked oponion before…

towardsutopia21

easy boy, down!! if you are better than schweser, you will pass… dont let book 7 get to you