Analyzing the Yield Curve A yield curve is a graph which shows the relationship between the yields and maturities of bonds with similar risk. It’s also called as the term structure of interest rates since it describes the interest rates of bonds with different maturities…
The figure below shows the yield curve of US Treasury of 11th February 2011. The key point here is that only bonds with different maturities of US Treasury have been selected since they are default free and do not have credit risk associated with them. Despite the fact that these bonds are risk free than why the yield curve is positive sloping that is its yield is increasing with an increase in maturities. Figure 1: US Treasury bond yields as of Feb 11, 2011 (Source: www.bondsonline.com) Table 1: Yield on US Treasury bonds with different maturities The reason why it’s upward sloping is because the curve shows the expectations of the investors about future interest rates. The investors require a higher rate of return as a compensation for lending their money for a longer period of time. In addition to that, the figure also reveals that as the Fed rate is currently on a very lower side therefore the market believes that in the future the returns will adjust due to inflation and other macroeconomic factors. This is more related with the expectations theory of the investors. The yield curve shifts over the period of time that is interest rate of different maturities increase or decrease on similar risk bonds. This is for a number of reasons that causes shifts in yield curves. Firstly, the economic scenario in a country determines how the yield curve should behave. ...
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