1. © K. Cuthbertson and D. Nitzsche Figures for Chapter 8 FORWARD RATES, YIELD CURVES AND THE TERM STRUCTURE (Investments : Spot and Derivatives Markets)

2. © K. Cuthbertson and D. Nitzsche Figure 8.1 : Actual forward-forward agreement t = 0t = 1 Time Receive $110.50 Lend/pay out $100 t = 2 f 12 = 10.5%

3. © K. Cuthbertson and D. Nitzsche Figure 8.2 : Synthetic forward (sf 12 ) t = 0t = 1 Time Receive $111 Repay $100 t = 2 sf 12 = ? Lend $91.74 at r 2 = 10% Borrow $91.74 at r 1 = 9% r 2 = 10% r 1 = 9%

4. © K. Cuthbertson and D. Nitzsche Figure 8.3 : Synthetic forward rate (sf 12 ) Time r 1 = 9% t = 0t = 1 t = 2 sf 12 plus 1-year investment at r 1 yields the same dollar amount as the 2-year investment at r 2. sf 12 = 11% Difference (year-1) = 10% - 9% = 1% sf 12 = 10% + (10% - 9%) = 2r 2 - r 1 r 2 = 10%

5. © K. Cuthbertson and D. Nitzsche Figure 8.4 : Yield curves Upward sloping yield curve Downward sloping yield curve

6. © K. Cuthbertson and D. Nitzsche Figure 8.5 : Yield curve Yield Time to maturity If short rates are expected to rise then r 2 = 6% and r 3 = 7%. 1 23 A B B A 4% 6% 7%

7. © K. Cuthbertson and D. Nitzsche Figure 8.6 : Liquidity preference Yield Time to maturity Lenders like to lend at short horizon, borrowers like to borrow for long horizon, so long rates contain positive ‘liquidity premia’. liquidity premium Expectations hypothesis Liquidity Preference