FIN435 • Chapter 6 Class Notes Spring 2026

Read-through notes to review Chapter 6 concepts quickly. Define → connect to real life → interpret the yield curve.

Theme:

Chapter 6 Website (Interactive) FRED DGS2 (2Y) FRED DGS10 (10Y) Expectation Theory Tool

Exam mindset: you should be able to explain, in normal English, how the Fed affects short rates, how the market prices long rates, and what an inverted curve might signal.

Quick Start (what to say in 60 seconds)

SOFR is an overnight rate based on Treasury-backed repo transactions; it is a major modern benchmark.
The Fed influences short-term rates; those changes transmit into consumer borrowing rates.
2Y reflects expected policy over ~2 years; 10Y reflects long-run expectations + term premium.
2s10s spread = 10Y − 2Y. Negative (inverted) often means markets expect rate cuts and slower growth.
Expectations theory uses long vs short yields to infer an “implied future short rate” (approx; term premium exists).

Collapsible Notes

1) SOFR: what it is and why it matters

SOFR = Secured Overnight Financing Rate (overnight borrowing backed by Treasury collateral).
It is a key reference for floating-rate markets and modern benchmark plumbing.
Because it is overnight, it moves closely with money-market conditions and the Fed’s stance.

SOFR is a “base overnight rate” in big finance. If it goes up, many borrowing costs tend to drift up too.

2) Rate transmission: how the Fed reaches your borrowing costs

Fed policy affects very short rates first (overnight / short-term funding).
Banks’ funding costs move → banks re-price loans (especially variable-rate products).
Consumer rates often look like: Benchmark + credit risk + term + fees/margins.

Why credit cards are “sticky high”: credit risk + large margins; even when policy eases, banks may not cut as fast.

3) 2-year vs 10-year: what each one “means”

2Y is mainly about expected Fed policy over the next ~2 years (market view of near-term path).
10Y is about longer-run inflation/growth expectations plus a term premium.
Many long-term borrowing rates are anchored by longer Treasuries (especially the 10Y) plus spreads.

Use official daily yields from FRED: DGS2 and DGS10.

4) The 2s10s spread (10Y − 2Y): how to interpret

Spread > 0: “normal” curve (markets not strongly expecting big cuts soon).
Spread ≈ 0: flat curve (uncertainty / transition).
Spread < 0: inverted (markets may expect future easing / slower growth).

Important: inversion is a signal, not a guarantee. Discuss it as market expectations + risk/term premium.

5) Yield curve shapes: normal, flat, inverted, humped

Normal: long rates > short rates (positive slope).
Inverted: long rates < short rates (negative slope).
Humped: mid-maturities highest (complex expectations + term premium dynamics).

Always connect the curve shape to: expected policy path + inflation/growth expectations + term premium.

6) Corporate yield breakdown (Treasury vs corporate spread)

Required return components (conceptual): r = r* + IP + DRP + LP + MRP

DRP = default risk premium (credit risk).
LP = liquidity premium (harder to sell quickly).
Corporate − Treasury spread is often interpreted as DRP + LP (roughly).

Spreads widen in risk-off periods, recessions, or when liquidity dries up.

7) Expectations theory: “2-year vs roll 1-year” (practical meaning)

Two strategies:

Strategy A: Buy a 2-year Treasury today and hold it (lock the 2Y yield).
Strategy B: Buy a 1-year Treasury today, then next year buy another 1-year (roll over).

Expectations theory says the market prices yields so that the expected total return is similar (ignoring term premiums). That lets us infer the “implied” future 1-year rate from today’s 1Y and 2Y yields.

Indifference condition:

(1 + a)^N = (1 + b)^M · (1 + c)^{(N − M)}

c = [(1 + a)^N / (1 + b)^M ]^1/(N−M) − 1

Use the dedicated tool for practice: https://www.jufinance.com/expectation_theory/. Remember: real long yields include a term premium, so this is an approximation.

8) What to memorize for Exam 1 (minimum)

Definitions: SOFR, yield curve, term premium, spread.
Interpretation: what 2Y vs 10Y represent.
2s10s spread meaning (normal vs inverted) and what it suggests.
Expectations theory: explain the rollover intuition and use the calculator.
Corporate spread components: default + liquidity.