TRADING CASE B06
Private information and the term structure of interest rates
LEARNING OBJECTIVE
Apply efficient-market concepts when traders receive private information about future spot rates.
KEY CONCEPTS
Term structure | Informational efficiency and rational expectations | Information and the shape of the term structure | Unbiased expectations | Liquidity premium
EVOLUTION OF ONE-MONTH SPOT RATES
HOW THE CASE WORKS
B06 uses the same three bonds, trading schedule, and rate tree as B05. Borrowing and short sales are allowed; students set prices with bids and asks.
PRIVATE INFORMATION
Each month the next rate can make a high (x), middle (y), or low (z) move. A truthful message such as Not y eliminates the middle move. Messages are distributed so the market as a whole knows more than any single trader.
Use your message with the tree and market prices to assess how information becomes reflected in the term structure.
BOND CASH FLOWS
| Bond | Month 1 | Month 2 | Month 3 |
|---|---|---|---|
| GKO-1 | 100 | 0 | 0 |
| GKO-2 | 0 | 100 | 0 |
| GKO-3 | 0 | 0 | 100 |