The Yield Curve for the United Kingdom - Assignment Example

The Yield rates By + Introduction This refers to a line that shows the interest rates of bonds overa period of time with the same quality of credit but with different dates of maturity. In most cases the curve is used to compare certain durations of the bonds and these includes the 3 month, 2 year, 5 year and 30 year T bonds. The curve is very important in any given economy as it is used to gauge other rates in the market such as the lending rates for banks and the mortgage interest rates. It can be a very useful too in the prediction of the economic growth rate and the output. The yield curve for any economy can either be inverted, normal or flat. A normal curve shows that over a period of time, long term bonds will yield higher returns than shorter duration bonds because of the reduction of risks over a greater period of time (Bhole, 2009). An inverted yield curve shows that short term bonds will perform better than long term bonds and in most cases this is an indication of a coming recession. When the yield curve is flat it implies that there is a close relationship between the various returns over short and long term periods of time and usually shows that the economy of a given country is undergoing some sort of transition. It is therefore correct to say that an increase in the angle of the slope is directly proportional to an increase in the difference between the long and short term interest rates of the bonds. Below is an image showing a normal yield curve. The Yield Curve for the United Kingdom is as follows. The Current Outlook for Interest Rates The yield curve for the economy is a normal yield curve shows that long term investment s will most likely yield a higher return than short term investments over a period of time. Currently, the interest rates are very low and this is a bad situation for possible investors. The bank of England decided to hold its interest rate at 0.5 % given that they are not expected to change positively until sometime next year. However, there is anticipation that the economy will perform well in future particularly due to an anticipated increase in industrial production over the next few years (Dawe, 2009). This shows that in the future the interest rates are likely to increase. However, presently, the interest rates are very low due to the various factors in the economy. One of these is unemployment which is at above 7% and has been recorded at a high of 7.3%. The inflation rate has also slowed down to a low of 1.7% and this is the lowest that it has ever been since the year 2009. Expectations about how interest rates will evolve in the future The interest rates are a major determinant of the direction in which our economy is headed. When the interest rates are low it means that the economy is operating at a low and this will most likely affect other areas of the economy. According to me, the economy seems to be performing well given that industries are still producing goods and services, financial institutions are giving out cash more willingly. However, the economy is affected by other world economies and it is likely that because there is an overall increase in the global interest rates the same will affect the rates in the country. How to take advantage of low interest rates When the interest rate is at such a low level, it can be useful to the consumers in various ways. It is important to note that change in the level of interest rates is only a temporary measure and they are likely to increase in the near future to As a consumer, I can take advantage of this to be able to access financial services that were previously unattainable due to high interest rates. This is because it lowers the cost of borrowing and makes it easier for banks to lend their money while at the same time making it easier for consumers to spend more money while purchasing goods and services in the given economy. This is seen to be more beneficial to spend their money. Despite this, it is the time at which consumers can take advantage of the borrowing rates to borrow more cash from the lending institutions because the money will be given to them at very low interest rates. However, there I s the risk that these interest rates will rise in future and this can be passed on to the consumers and they might have to pay higher borrowing costs (Choudhry, 2004). This can also be the correct time for people to buy houses since the mortgage rates are at an all-time low. They can therefore get housing units at a much cheaper rate than in previous times and so can take advantage of the rates not only to buy houses but also to refinance their mortgages into more acceptable repayment options. Given that the interest rates are at an all-time low, saving in Banks is also not a worthy invested. I can take advantage of the low interest rates to invest in funds that deal in high yield dividend stocks and as such I can receive higher returns over the long run. However, these returns are only in the long term but if consumers want higher returns in the short term that can invest in other areas since these returns are only guaranteed over a longer period of time. According to this economics, the supply and demand of goods have a direct impact on the price of the commodity. This is the same as in the case of the interest rates. When there is an increase in the supply of a product the demand for the product is expected to drop. The demand for products is highest when the supply of a given product is quite low. In that scenario, people are willing to pay an extra amount so as to get the product since it is not readily available. On the other hand, when the supply is high, the demand is low and this pushes the price of the product much lower so as to increase uptake. Any given market consists of sellers and buyer each with a particular product or service that they want to sell to others; this is the same case with interest rates. The rates are usually determined by the supply and the demand of the particular product. The law of demand states that there is an inverse relationship between the price of a product and the demand for the particular product. The higher the price of a good the lower the demand of the particular good. On the other hand the lower the price of a good the higher the demand for the particular goods. The demand curve is downward sloping as illustrated in the diagram below. The direct curve is a direct reflection of the marginal benefit that is obtained when consuming goods. Consumers are willing to pay a high amount for goods but as additional units are consumed there is less satisfaction that is derived from the product, as such they will be willing only to pay a small amount (Fabozzi, 2007). Furthermore, when the price of a good is reduced it becomes cheaper than the prices of the other goods and so the quantity demanded is higher. The income effect also comes into play whereas the prices are reduced, the consumers have some money left and this makes them slightly richer. There is an increase in their buying power. This implies that they can buy more of that type of goods or other that they may be interested in. The demand of goods is further affected by the prices of other related goods. These are complements and substitutes, Substitutes are a direct replacement to a particular class of goods. This means that if the price of good increases consumers will simply shift to alternative goods. Complements are goods that are used together. If the price of one of these goods increases then the demand is likely to drop, as such the demand for the complements also drops. The supply curve shows that an increase in prices results to an increase in supply. The producers are more willing to produce goods if they expect to get higher returns. There are several factors that might affect the supply of a good and they include; prices of other related goods, production techniques and taxes and subsidies that have been offered by the government. The equilibrium is the point at which the demand curves and the supply curves intersect. The quantity demanded of a particular good can change due to various factors such as a change in the tastes and preferences of the consumers. This means that at the present selling price there will be more stock in the market (surplus) resulting in a decrease in the prices of the goods. As such this new equilibrium will occur at a point that has a lower price and a related lower quantity. Bibliography BHOLE, L. M. (2009). Financial institutions and markets: structure, growth and innovations. New Delhi, Tata McGraw-Hill. BROWN, P. J. (2008). Bond markets: structures and yield calculations. Chicago, Glenlake Pub. Co. CHOUDHRY, M. (2004). Advanced fixed income analysis. Amsterdam, Elsevier Butterworth-Heinemann. DAWE, D. C. (2009). Defining productivity and yield. Makati City, Philippines, International Rice Research Institute. FABOZZI, F. J. (2007). Floating rate securities. New Hope, Pa, Frank J. Fabozzi Assoc. Read More