NewsWire--SEPTEMBER 10, 1996

TOPIC: Interest Rates

SOURCE: "Bonds Slide as Investors Brace for Jobs Report," Wall Street Journal, C15.

SYNOPSIS: Bond yields rose and bond prices fell on Thursday, September 5 as the consensus developed that employment numbers due out on Friday, September 6 would indicate a drop in unemployment. While this would appear to be good news for the economy, it also suggests the potential for inflation and gives the Federal Reserve more reason to increase interest rates at their upcoming meeting. The article stresses the important role of inflationary expectations in setting interest rates and bond prices. The accompanying chart illustrates the current upward sloping yield curve and the general rise in interest rates during the last four weeks. A table provides comparative yields on a variety of bond classes. This is useful for examination of the default risk premium (DRP, pp. 126, 128). [The current unemployment statistic, released on Friday morning, was 5.1%, even lower than consensus expectations. As a result, bond prices fell even more during Friday's trading.]

DISCUSSION QUESTIONS:

1. Explain why investors and traders are so interested in the monthly employment report. Why is this information particularly interesting to the bond market?

2. Describe the shape and recent movement of the Treasury Yield Curve. Which term structure theories are consistent with this shape?

3. Use the data in the Yield Comparison table to determine the default risk premiums (DRPs) between Treasury issues and (i) High Quality corporate issues and (ii) Medium Quality corporate issues. Do this for both the 1-110 year maturities and the 10+ year maturities. Briefly discuss your findings.