A T-Bill with a face value of $100 that will mature in one year is sold at $96 today. If you deposit $100 in a saving account, you will get $110 in three years. Calculate the term spread (%) between 3-year and 1-year rates (Is there a yield curve inversion?).

Answer 1

To calculate the term spread between the 3-year and 1-year rates, we need to compare the yields on the two investments. The yield on the T-Bill can be calculated using the formula:

Yield on T-Bill = (Face Value - Purchase Price) / Purchase Price

Yield on T-Bill = ($100 - $96) / $96
Yield on T-Bill = $4 / $96
Yield on T-Bill = 0.0417 or 4.17%

The yield on the saving account can be calculated using the formula:

Yield on Saving account = (Future Value - Present Value) / Present Value

Yield on Saving account = ($110 - $100) / $100
Yield on Saving account = $10 / $100
Yield on Saving account = 0.1 or 10%

The term spread is the difference between the two yields:

Term Spread = Yield on Saving account - Yield on T-Bill
Term Spread = 10% - 4.17%
Term Spread = 5.83%

Therefore, the term spread is 5.83%.

Since the yield on the 3-year saving account is higher than the yield on the 1-year T-Bill, there is no yield curve inversion. A yield curve inversion would occur if the yield on the longer-term investment is lower than the yield on the shorter-term investment.