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Yield Curve Predictor

1. Discuss the Yield Curve and its usefulness in predicting recessions. Did the Yield Curve from 2004 through 2007 predict the Great Recession of 2008-2010? Based on the current Yield Curve, detail your prediction for the U.S. economy for the next two years.

2. Discuss ways in which an investor can take advantage of a flat or inverted yield curve. Give three current, specific real-world examples in your discussion.

Solution Preview

1- The yield curve identifies the relationship between the current interest rates and the time to maturity on a debt obligation. The curve works by forming a slope based on the information obtained from short term interest rates and long term interest rates. The data used to form the curve is based on the bond or security obligation having the same general characteristics as the others with the only exception being a different time to maturity. The yield curve is then used to determine the potential changes in economic growth or decline. It has proved to be very useful in predicting recessions. The Federal Reserve has openly stated that the yield curve has predicted all recessions except one, which was in 1967, and was considered a slowdown and crunch in economic progress.

The yield curve from 2004 to 2007 did predict the recession - but it was much too late. What we saw was called an inverted yield curve. With an inverted yield curve, long term debt has a lower yield than short term debt. This was apparent by all of the housing contracts that were signed with very low rates -- so low that it caused the housing bubble in 2008-2010, where many people who ...

Solution Summary

This solution provides a detailed discussion of the yield curve and its usefulness in predicting recessions. I specifically address if the yield curve predicted the recession of 2008-2010. A detailed prediction of the U.S. economy for the next two years is provided. This solution also includes a detailed discussion of ways in which investors can take advantage of a flat or inverted yield curve. Several current, specific real-world examples are provided. References are also provided for further student knowledge.