Yield Curves of US and Europe

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Financial Market Assessment 3

Question 1:
24/09/2020
Time to Maturity Euro area Central Government
Bond Yield Rates
U.S. Treasury
Bond Yield
Rates
1 Mo - 0.08%
3 Mo -0.60% 0.10%
6 Mo -0.62% 0.11%
1 Yr -0.66% 0.12%
2 Yr -0.71% 0.14%
3 Yr -0.74% 0.16%
4 Yr -0.74% -
5 Yr -0.72% 0.27%
7 Yr -0.63% 0.46%
10 Yr -0.49% 0.67%
20 Yr -0.17% 1.19%
30 Yr -0.05% 1.40%
1)The description the yield curves of US and Europe
Since bond yield rate is considered as discount rate that is mainly related with interest rate, so
any reduction in interest rate leads to decrease the bond yield as well, with increase of bond
price. Similarly, with increase in rates of interest cause the rise of bond yield which in turn,
create declination of bond’s market value. As per the data mentioned above, it has been
interpreted that from three months, Central Government Bond Yield Rates has been decreased
with 60% negative till 0.05% in 30- year maturity period. However, there is no specific data given
in 1- month. In addition to this, graphically, this data gives a humped yield having bell - shape
curve with a negative slope as data of both short and long term is lesser than medium-term.
Therefore, through this structure it has been analyzed that European economy is developing at
slow rate. This leads to lower inflation with decrease interest rate for the given financial periods.
On contrast with US treasury bond yield, its data represents a gradually increase from lowest to
highest figure i.e. 0.08% in first month to 1.40% till 30-year period of maturity. This data
represents a normal yield therefore, concerning on the current rate of short-term, it has been
expected that future short-term interest rate will be higher. Therefore, on comparing data of
both countries, it has been expected that relatively there will be a stronger economic growth
rate of US than Europe.
The yield curve of Europe:
The yield curve of US:

QUESTION 1 (continued)
1) Calculate the market price of each bond on 24th September 2020 that issued by North Polar
Ltd., a European company specialises in manufacturing semiconductors, using the yield
curve data provided in the table above. What is the current total value of minimum application?
Corporate Bonds Fact Sheet
Issuer North Polar Ltd.
Issuing date 24th September 2020
Bond expiration date 24th September 2025
Face value € 1000 per bond.
Minimum application 50 Bonds (€ 50,000)
Interest rate Floating Interest Rate. The Interest Rate is the sum of the
Market Rate plus the Margin.
Coupon rate (annual) Central Government Bond Yield + 1.86% p.a.
Coupon payment Annually (coupon payment is paid on 10th July every year)
Market Yield 4.5%
[4 marks]
2) Suppose the Australian government has announced tax cuts for the business sector. Using
the loanable funds model, explain how this will impact the supply of and demand for
loanable funds and the interest rate in Australia. (Explain your answer using diagrams).
Coupon rate (annual) = – 0.72% + 1.86% = 1.14%
INT = 1.14% x € 1000 = € 11.4
k_d= 4.5% = 0.045
Bond price = = € 852.50
Current total value of 50 Bonds = € 852.50 x 50 = € 42,624.84 € 42,625
To determine the supply and demand for loanable funds in Australia, interaction between both factors
i.e. supply and demand loanable funds are determined first to evaluate the interest rates. So, using
loanable funds model, level of interest rate could be partially explained.

Afterwards, loanable funds supply is then determined by calculating saving rates, lending decisions
regarding with surplus economic units (such units include income which is greater than expenditure)
and financial intermediaries’ lending policy. So, considering such factors, if taxes are cut for business
sector by Australian government then savings amount of households will rise up. This leads to raise
supply of loanable funds with decrease in interest rate.
Regarding with demand of loanable funds, it has been determined by analyzing the expenditure plans
about deficit economic units including further requirement of financing such expenditures, by using
borrowed funds. So, demand for finance will be rise for both household and business requirements in
terms of high expenditures for housing etc., if interest rates are lower interest rate with increased supply
of loanable funds. This will enable Australian Government to push back the interest rate back till that
point after which tax cuts will take place.