PRICE COMPLEXITY

AM | @MackinlayEuruni

Sources. Hooman Estelami. Marketing Financial Services. New York: Dog Ear Publishing, 2006 (introduction, p. 12; chapter 4, p. 109).
_____________

. Estelami: "The prices of financial services are intrinsically complex. For example, the lease price of an automobile might consist of monthly payments, the number of payments and a down payment, rather than the single sticker price used when purchasing the vehicle with cash. Often the price consists of multiple numbers, some of which the consumer may not even completely understand. this not only makes the task of understanding the various prices available in the marketplace difficult for the consumer, but it also creates scenarios that may lead to deceptive and, in some cases, unethical practices from marketers (p. 12).

Revolving credit has no specific time limit, but should be used by consumers as a short-term instrument for borrowing. An example of revolving credit is credit card debt. Since revolving credit is of a short-term nature, associated rates of interest are often linked to short-term interest rates. On the other hand, non-revolving credit is often associated with longer-term interest rates, such as US Treasury rates" (p. 109). What a statement! And a wonderful opportunity to briefly introduce the notion of the yield curve.

* * *

The yield curve: a very brief mention. Frank J. Fabozzi. Fixed Income Mathematics. Analytical & Statistical Techniques. Chicago: Probus, 1993, chapter 13.

The graphical depiction of the relationship between the yield on securities of the same credit risk and different maturity is called the yield curve. The yield curve is constructed with the maturity and observed yield of Treasury securities because Treasuries reflect the pure effect of maturity alone on yield, given that market participants do not perceive government securities to have any credit risk. When market participants refer to the “yield curve”, they usually mean the Treasury yield curve. This is also true in the bond markets of other countries.

The exhibit shows four yield curves that have been observed in the US Treasury market (and occur in other major government bond markets). In the yield curve in panel B, the yield increases with maturity. This shape is commonly referred to as an upward sloping or normal yield curve. The yield curve on panel C is downward sloping or an inverted yield curve. In a humped yield curve, depicted in panel D of the exhibit, the yield curve initially is upward sloping, but after a certain maturity it becomes downward sloping. Finally, a flat yield curve is one where the yield is the same regardless of the maturity. A flat yield curve is shown in panel A.

. US Department of the Treasury: Daily Treasury Yield Curve Rates; Bloomberg Yield Curves
__________________