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Questions:
a. Pick the month you were born. Draw the yield curve for that month in 2008 and 2009. Also, draw the yield curve for the month falling exactly in the middle. (For instance, if you were born in April, draw the yield curves for April 2008, October 2008 and April 2009.)

b. What should be the shape of the yield curve under normal circumstances? Why?

c. Compare the shapes of the three yield curves that you have drawn. From the yield curves, can you infer anything about the market’s expectation about the future of Australian economy?

d. What is the yield on 2-year bond in January 2008? Under the expectations theory, what interest rate do investors expect on a 1-year bond next year (i.e., January 2009)? Using the same method calculate the expected interest rates on 1-year bonds for all the months of 2009.

e. How do the expected interest rates compare with the actual interest rates in 2008? Do your calculations validate/not validate the expectations theory? List some possible reasons why the expectations hypothesis may not hold.

For questions f – g, consider both Australian Government Bonds and NSW Treasury Bonds for the period January 2008 – December 2009.

f. For 3, 5 and 10 year bonds what was the average spread between Australian Government Bonds and NSW Treasury bonds?

g. Draw a graph plotting the spread between Australian Government Bonds and NSW Treasury Bonds. Comment on the pattern of the spread. Can you provide an explanation for this pattern?

In a normal yield curve, a short term debt’s yield curve has lower yield than a long term debt instrument. Due to it, the yield curve of the company gets an upward slope. It is the most common yield curve shape and it is referred as “positive yield curve”. The yield curve differs like this because of the fact that investors expect higher return from the instruments which are offering higher risk to the investors.

The higher yield compensate the higher risk of the investors and due to it, it is the normal yield curve (Diebold, Rudebusch and Aruoba, 2006). The normal shape of yield refers the expected shift in yields due to the extension in the maturity date in time in the debt instruments.

Part c:

According to the below drawn shape, it has been found that the short term debt’s yield curve has lower yield than long term debt instrument. Due to it, the yield curve of the debt instrument gets an upward slope. The yield curve explains that the investors expect higher return from the instruments which are offering higher risk to the investors. The higher yield normally compensates the higher risk of the investors and it leads to the normal yield curve. The yield curve explains that the performance of the Australian economy would be improved as the total return would also be increased.

 Yield on two year's bond Year-1 Year-2 Actual interest rate Year 2 Actual interst rate Year -1 Expected Interest rate Jan-2009 2.69% 2.83% 1.05741 1.0269 1.02971 Feb-2009 2.59% 2.80% 1.05685 1.0259 1.03017 Mar-2009 2.74% 2.87% 1.05826 1.0274 1.03004 Apr-2009 2.69% 3.16% 1.06419 1.0269 1.03631 May-2009 2.87% 3.46% 1.07039 1.0287 1.04053 Jun-2009 2.95% 3.90% 1.07961 1.0295 1.04867 Jul-2009 3.00% 4.04% 1.08242 1.03 1.0509 Aug-2009 3.19% 4.57% 1.09349 1.0319 1.05968 Sep-2009 3.23% 4.42% 1.0904 1.0323 1.05628 Oct-2009 3.66% 4.82% 1.09877 1.0366 1.05998 Nov-2009 3.73% 4.71% 1.09645 1.0373 1.05702 Dec-2009 3.83% 4.54% 1.09282 1.0383 1.05251

Expectations theory explains that the forward rates exclusively explain the expected future rates. The entire term structure of bond explains the expectation of market in terms of future short term rates. Such as, an increasing slope of term structure explains about increment in the short term rates.

The below given rates also differ that the expected interest rate of the term structure is higher than the actual interest rate of the business. It explains that the expectation of the market is higher in the future. This validates the expectations theory (Brandt and Kavajecz, 2004). The expectations theory could not be hold because of the fact that the money’s value couldn’t be same in near future and thus the investors demand for the return accordingly. As well as the investor invest into the market to get higher return which is not hold in the expectation theory.

 spread between Australian Government Bonds andNSW Treasury bonds F2  CAPITAL MARKET YIELDS - GOVERNMENT BONDS Per cent per annum Australian Federal Government NSW Treasury Difference Years to Maturity Years to Maturity Years to Maturity Date 3 yrs 5 yrs 10 yrs 3 yrs 5 yrs 10 yrs 3 yrs 5 yrs 10 yrs Jan-2008 6.58 6.34 6.08 6.99 6.92 6.58 -0.41 -0.57 -0.50 Feb-2008 6.75 6.50 6.29 7.33 7.26 6.96 -0.59 -0.76 -0.67 Mar-2008 6.21 6.10 6.09 6.94 6.90 6.82 -0.74 -0.80 -0.73 Apr-2008 6.25 6.19 6.17 6.89 6.84 6.78 -0.64 -0.65 -0.61 May-2008 6.47 6.33 6.36 7.02 6.91 6.89 -0.54 -0.58 -0.54 Jun-2008 6.84 6.69 6.59 7.36 7.23 7.10 -0.52 -0.54 -0.51 Jul-2008 6.49 6.40 6.37 7.14 7.05 7.01 -0.65 -0.65 -0.64 Aug-2008 5.74 5.77 5.86 6.35 6.38 6.49 -0.62 -0.61 -0.63 Sep-2008 5.48 5.54 5.65 6.21 6.24 6.33 -0.73 -0.70 -0.69 Oct-2008 4.59 4.83 5.22 5.27 5.48 5.85 -0.68 -0.65 -0.63 Nov-2008 3.96 4.28 4.94 4.75 5.14 5.69 -0.79 -0.87 -0.75 Dec-2008 3.43 3.72 4.22 4.54 4.87 5.12 -1.10 -1.15 -0.90 Jan-2009 3.15 3.50 4.09 4.27 4.64 4.93 -1.12 -1.14 -0.85 Feb-2009 3.08 3.59 4.25 3.96 4.50 5.21 -0.88 -0.91 -0.95 Mar-2009 3.20 3.73 4.33 4.24 4.87 5.62 -1.05 -1.14 -1.29 Apr-2009 3.53 4.05 4.51 4.32 4.93 5.59 -0.79 -0.88 -1.07 May-2009 3.91 4.47 5.00 4.52 5.17 5.90 -0.61 -0.69 -0.90 Jun-2009 4.47 5.10 5.56 5.02 5.70 6.36 -0.55 -0.59 -0.81 Jul-2009 4.59 5.21 5.49 5.07 5.63 6.12 -0.48 -0.42 -0.63 Aug-2009 4.99 5.39 5.53 5.40 5.77 6.09 -0.41 -0.37 -0.55 Sep-2009 4.82 5.14 5.32 5.12 5.54 5.86 -0.31 -0.40 -0.54 Oct-2009 5.14 5.35 5.45 5.47 5.77 5.98 -0.33 -0.41 -0.53 Nov-2009 4.99 5.24 5.47 5.34 5.67 6.05 -0.35 -0.43 -0.58 Dec-2009 4.83 5.15 5.47 5.21 5.60 6.09 -0.39 -0.45 -0.62

The spread between Australian Government Bonds and NSW Treasury bonds is lower. However, these changes brief that the performance of NSW treasury bonds are better than the Australian government bonds (Gürkaynak, Sack and Wright, 2007).

On the basis of the below give figure 5, it has been observed that the stock price of QAN was lower than stock price of AMP at initial stage but after March, 2017, the stock price of QAN has been higher. It briefly explains that the performance of QAN is much better as the curve is going upward whereas the graph of AMP describe about the downward situation of the company.

 c ASX200 QAN.AX (\$A) AMP.AX (\$A) Jan-15 Feb-15 -0.63% -3.88% 7.96% Mar-15 -1.72% 2.07% 8.65% Apr-15 -0.22% 3.42% 3.83% May-15 -5.51% -9.61% -10.23% Jun-15 4.40% 9.80% 18.67% Jul-15 -8.64% -9.98% -10.40% Aug-15 -3.56% -6.55% 10.71% Sep-15 4.34% 5.54% -0.29% Oct-15 -1.39% 1.40% -7.85% Nov-15 2.50% 0.34% 12.36% Dec-15 -5.48% -7.89% -5.13% Jan-16 -2.49% -0.93% -0.52% Feb-16 4.14% 8.83% 5.44% Mar-16 3.33% 4.30% -20.88% Apr-16 2.41% -4.08% -4.35% May-16 -2.70% -8.51% -8.44% Jun-16 6.28% 12.60% 12.06% Jul-16 -2.32% -9.47% 2.53% Aug-16 0.05% 3.04% -3.70% Sep-16 -2.17% -13.45% 0.14% Oct-16 2.31% 2.84% 7.84% Nov-16 4.14% 7.23% 0.91% Dec-16 -0.79% -0.79% 2.40% Jan-17 1.62% -2.40% 9.97% Feb-17 2.67% 9.16% 3.73% Mar-17 1.01% 3.47% 11.07% Apr-17 -3.37% -5.78% 18.16% May-17 -0.05% 2.77% 14.17% Jun-17 -0.02% 3.85% -6.99% Jul-17 -0.11% -5.38% 7.52% Aug-17 -0.58% -2.53% 1.92% Sep-17 4.00% 2.90% 6.81% Oct-17 1.03% 2.82% -7.80% Nov-17 1.59% 1.57% -11.11% Dec-17 -0.45% 1.16% 4.56% Jan-18 -0.36% 0.76% 11.76% Feb-18 -4.27% -3.05% -1.02% Mar-18 3.88% -19.04% 0.16% Apr-18 0.49% -3.47% 10.05% May-18 3.04% -8.72% -2.99% Jun-18 0.53% 0.00% 9.09%

 ASX200 QAN.AX (\$A) AMP.AX (\$A) Mean 0.17% -0.87% 2.46% Variance 0.10% 0.45% 0.77% Standard Deviation 0.032 0.067 0.088 Covariance 0.118% 0.061%

On the basis of the above data, it has been found that the overall performance of AMP is better in terms of stock price. The fluctuations in the stock price of AMP are also lower than the stock prices of QAN.

Calculation of beta:

 ASX200 QAN.AX (\$A) AMP.AX (\$A) Mean 0.17% -0.87% 2.46% Variance 0.10% 0.45% 0.77% Standard Deviation 0.032 0.067 0.088 Covariance 0.118% 0.061% Beta 1.172 0.610

On the basis of the above table in part c, it has been measured that the beta of QAN is 1.172 and the beta of AMP is 0.610. The Qantas has higher beta which represents that the volatility in the stock of Qantas is higher than volatility in the index stock price. Further, the AMP has lower beta than 1 which represents that the volatility in the stock of AMP is lower than the volatility in the index stock price (Bello, 2005).

 QAN.AX (\$A) Calculation of cost of equity (CAPM) Risk free rate (Bloomberg, 2018) 1.69% RM 2.05% Beta 1.172 Required rate of return 2.11% AMP.AX (\$A) Calculation of cost of equity (CAPM) Risk free rate (Bloomberg, 2018) 1.69% RM 2.05% Beta 0.610 Required rate of return 1.91%

It represents that the stock price of both the company is underpriced as the market price of both the stocks are lower than the actual stock price of the stocks.

The report focuses on the past and future performance of QAN stock and AMP stock.

Analysis:

On the basis of the evaluation on the stock price of QAN and AMP, it has been recognized that earlier the stock performance of AMP was better. But along with the time, the performance of QAN has been better (Goetzmann and Kumar, 2008). The share price evaluation explains that the performance of QAN is much better as the curve is going upward whereas the graph of AMP describe about the downward situation of the company in current scenario.

If the average price of both the company is considered than the performance of AMP is higher. The report briefs few internal changes have affected the stock price of AMP which has been revoked due to which the stock price has been improved again. On the basis of overall evaluation, the future prospects of both the companies are good but the performance of Qantas would be better (Guiso and Jappelli, 2008).

Conclusion:

On the basis of the report, it has been found that the overall performance of both the company has been changed. The QAN stock price performance explains about higher changes than the AMP stock price and thus the future prospect of QAN stock is better. However, the future prospects of both the company shows about positive changes as the returns of both the companies are positive as well as dividends attract the investors to invest more in the company which will lead to the higher stock price and better future of the company.

References:

Bello, Z. Y. 2005. Socially responsible investing and portfolio diversification. Journal of Financial Research, 28(1), 41-57.

Brandt, M.W. and Kavajecz, K.A., 2004. Price discovery in the US Treasury market: The impact of orderflow and liquidity on the yield curve. The Journal of Finance, 59(6), pp.2623-2654.

Diebold, F.X., Rudebusch, G.D. and Aruoba, S.B., 2006. The macroeconomy and the yield curve: a dynamic latent factor approach. Journal of econometrics, 131(1), pp.309-338.

Goetzmann, W. N., and Kumar, A. 2008. Equity portfolio diversification. Review of Finance, 12(3), 433-463.

Guiso, L., and Jappelli, T. 2008. Financial literacy and portfolio diversification. CAGE publications.

Gürkaynak, R.S., Sack, B. and Wright, J.H., 2007. The US Treasury yield curve: 1961 to the present. Journal of monetary Economics, 54(8), pp.2291-2304.

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