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Freeport Bank and Hickman Savings and Loan

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Consider the following scenario:
Hickman Savings and Loan is concerned that market conditions might cause the short-term yield curve to be higher than the long-term yield curve. This negative yield curve means that long-term interest rates are lower than short-term rates. This will cause the bank to shift from its mortgage-based business strategy to one dominated by short-term loans, which is not an area that the bank has much market share. Explain how the yield curve is affected by the following:
? Liquidity preferences theory
? Market segmentation theory
? Expectation theory
? Other economic factors
Is it important for a bank to follow the yield curve? Why or why not?
Grading Criteria
Explain how the yield curve is affected by the liquidity preferences theory. 35%
Explain how the yield curve is affected by the market segmentation theory. 20%
Explain how the yield curve is affected by the expectation theory. 20%
Explain how the yield curve is affected by other economic factors. 20%
APA citation and references (if applicable) or the percentage will be assessed in the criteria above. 5%

Consider the following scenario:
Freeport Bank is committed to increasing its commercial mortgage market share but is concerned about interest rate risk. Write 250 words explaining to the bank's management team the various types of interest rate risk. Be sure to address the following components of interest rate risk:
? Market risk
? Reinvestment risk
? Inflation risk
How important is interest rate risk to Freeport Banks long-range strategic planning? How can the bank protect itself from these types of interest rate risk?
Suggestions for Reviewing Peer Posts
Compare and contrast the answers given by your peer to your own on the importance of long-range strategic planning and interest rate risk. What similarities or differences exist? What additional points can you make to support his or her responses?
Grading Criteria
Response to Discussion Questions 80%
Response to Peer Posts 15%
APA citation and references (if applicable) or the percentage will be assessed to response to peer posts 5%.

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Solution Preview

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The yield curve is not always upward sloping. It might be flat or even downward sloping. There are three theories which can explain this phenomenon:
Liquidity preferences theory
The liquidity preference theory has a macroeconomic perspective that focuses on money not saving which is necessary prerequisite for economy. Liquidity refers to demand for money. To forgo liquidity, consumers would have to let go of interest rates by not holding bonds. Money held yields no interest. However consumer does not spend this money, he has saved it. But rather than having reward for saving interest is reward for parting with liquidity. People like to hold liquid cash to meet any unforeseen future requirement. They also maintain liquidity against belief that bond prices would fall. When interest rate decreases people demand more money to hold until interest rate increases. As they have to wait for a longer duration, they demand greater liquidity premium. This is the reason for upward sloping yield curves. The theory dos not provide any explanation for downward sloping or flat yield curves. These are just considered anomalies.
Market Segmentation Theory
Market segmentation refers to the process of dividing the market into different consumer segments ...

Solution Summary

The solution discusses the Freeport Bank and Hickman savings and loan.

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