This graded activity will allow you to explore the Fisher Equation using Treasury Bonds. You are allowed to work on this activity in groups of 2 (pairs) or as individuals. No groups larger than 2 are permitted.
For this activity, you will create an Excel Workbook. In this Excel workbook, you should include the following:
Your name. If you are working as a pair, the names of both group members must be included.
Answers to all answerable questions on the following page. You should insert text boxes directly into the sheet and type your answers into those text boxes. All answers (and all calculations and graphs on which those answers are based) should be included in a single Excel workbook file
– Note: Be sure I can see any formulas you use.
The 5-year Treasury Constant Maturity Rate is a measure of the price the government pays to borrow, in nominal terms. Treasury Inflation Indexed Securities, or TIIS, are bonds that are inflation indexed, providing a measure of the real interest rate. Essentially, the TIIS securities adjust the 5-year Treasury bond yields for inflation. For this activity, you will consider yields from both nominal Treasury bonds and Treasury Inflation Indexed Securities.
– You will need to collect two series of data from the St. Louis Federal Reserve FRED data base. Collect data from January 1, 2005 - the most recent data available. The data should be at the weekly (ending Friday) frequency.
* 5-year Treasury Constant Maturity Rate (DGS5)
* 5-Year Treasury Inflation-Indexed Security, Constant Maturity (DFII5)
– Combine all data into a single data set. Be sure to match the dates between the two series.
1. Recall the Fisher Equation, i = r + πe. Which series corresponds to i and which to r?
2. In Excel, plot the yields for the Treasury Inflation-Indexed Securities over time.
(a) Are these yields ever negative? If so, during what time period?
(b) What does a negative yield in this security imply?
(c) In late 2008, there is a spike in the yields for Treasury Inflation-Indexed Securities. What are TWO possible explanations for this spike? (hint: consider the two factors that go into the determination of the yield for this security in the context of the Fisher Equation).
i. How can you determine which explanation is correct?
3. Calculate the spread between the 5-year Treasury Constant Maturity Rate (DGS5) and the 5-Year Treasury Inflation-Indexed Security, Constant Maturity (DFII5). Specifically, calculate DGS5 - DFII5. What does this difference represent?
4. In Excel, plot this difference between DGS5 and DFII5 over time. Is the difference constant over time?
(a) Is there a time period during which this difference sharply diverges from the other periods? If so, what can you infer about the expectations of market participants during the unusual time period?
5. What were the economic circumstances surrounding the time period during which the yields spiked? Explain the economic rationale behind this shock to yields. It may be helpful to use the basic Aggregate Demand/Aggregate Supply framework you developed in Intermediate Macroeconomics. If you want to include a graph of AS/AD, you should be able to create one pretty easily using the Shapes feature in Excel.
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