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CORPORATE FINANCE
Executive Summary
This assignment deals with the yield curve of different economies. The various shapes of the yield curve and the related theoretical concepts have been discussed in initial part of the assignment. The yield curve of U.S.A has been discussed in detail and the potential impact of the current yield curve have also been discussed. The impact of flattening of the yield curve on the stock market has been outlined to get a detailed idea of the topic. Finally, the impact of monetary policy of central government on the yield of bonds of different maturities has been discussed.
Table of Contents
Introduction    4
a) Different shapes of the yield curve    4
b) Yield curve associated with the government bond of USA    5
c) Impact of flattening of yield curve on stock market    6
d) Role of central bank    7
Conclusion    8
References    9
Introduction
The yield curve is a graphical representation of the rate of interest for a different range of maturities. The interest rate here refers to the coupon rate of government bonds. The yield curve at any point indicates the expectation of the investor from that bond. The different shape of the yield curve indicates performance of different economies. Flattening of the yield curve is considered as a warning symbol for the economy. The yield curve of U.S.A has been seen on an inverse trend in recent times.
a) Different shapes of the yield curve
The yield curve indicates expectation of the investor on the vertical axis and the maturity period on the horizontal axis. The shape of the yield curve varies according to the economic cycle. However, the same is upward sloping. Analysts use yield curve to indicate the economic cycle and predict the expectations of the investors. There are different types of yield curve such as normal yield curve, inverted yield curve, steep yield curve, flat yield curve and humped yield curve. Inflation, economic growth and interest rate are the major factors influencing the yield curve.
The normal yield curve is upward sloping indicating an existence of lending risk for longer period. It is riskier to lend money for a long period rather than short period. Higher the maturity period, higher the risk and hence higher is the expectation of the investor. The yield curve takes an inverted position when the long-term yield falls below the short-term yield. When the investors expect the inflation rate to decline, there is a decrease in long-term expectation of the investor.
A flat yield curve indicates the yield of all the maturities is same. This indicates that the investor would be indifferent among the various maturity options. He can invest in any bond, irrespective of the maturity period. Investors prefer to invest in securities that have a higher return and lower maturity. If all the bonds yield similar returns, a rational investor will investor for a short-term. This will help him in earning higher rate of return along with assurance of liquidity. This will lead to lack of funds in the market for long periods. This will have an impact on the investing activities that require a longer period. Therefore, as stated by Edwards (2018), the flattening of the yield curve is a matter of concern. The same will affect the long-term infrastructural development as well as economic development. The government should ensure that such a situation does not arise. Flattening of the yield curve will have a negative impact on the Gross Domestic Product of the economy, as the investment will dry up. This can have a negative impact on the employment situation of the economy.
b) Yield curve associated with the government bond of USA
In case of USA, there has been recent increased in the coupon rates of the short-term bonds by the Federal Reserve. The same has led to an inverted U.S.A Treasury yield curve. As there has been no change in the coupon rate of long-term bonds, the coupon rates of long term and short-term bonds has become similar. According to the views of Christensen (2015), an inversion of the yield curve generally indicates an economic downturn. Heavy requirement of money for short period leads to such decisions of increasing the yield of short-term bonds over long-term bonds. In early December last year, the yield of 2 years bond increased the yield on 5-year bond. This had led to an inversion of the yield curve. Inversion of yield curve leads to loss of money by financial organization on lending activities. In the year 2000, the yield curve had sunk to 0.30%. This has led to an increase in the lending standards from 10% to 60%.
Figure 1: Yield curve of United...