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Unraveling yield curve


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Unraveling yield curve

  1. 1. Unraveling the ‘Yield Curve’ - by Prof. Simply Simple
  2. 2. <ul><li>In finance, the yield curve is the relation between the interest rate (or cost of borrowing) and the time to maturity of the debt for a given borrower in a given currency. </li></ul><ul><li>For example, the current U.S. dollar interest rates paid on U.S. Treasury securities for various maturities are closely watched by many traders, and are commonly plotted on a graph informally called the ‘yield curve’ which is depicted in the previous slide. </li></ul>
  3. 3. So what is ‘yield’? <ul><li>The yield of a debt instrument is the annualized percentage increase in the value of the investment. </li></ul><ul><li>For instance, a bank account that pays an interest rate of 4% per year has a 4% yield. </li></ul>
  4. 4. In general… <ul><li>The percentage per year that can be earned is dependent on the length of time that the money is invested. </li></ul><ul><li>This earning for having invested your money in a particular investment instrument is called as ‘yield’. </li></ul><ul><li>Also, it is important to understand that the yield is not directly proportional to the length of the investment. ( It is not a straight line relationship) </li></ul>
  5. 5. So what are the uses of the Yield Curve? <ul><li>Yield curves are used by fixed income analysts, who analyze bonds and related securities, to understand conditions in financial markets and to seek trading opportunities. </li></ul><ul><li>Economists use the curves to understand economic conditions. </li></ul><ul><li>The yield curve function Y is actually only known with certainty for a few specific maturity dates. The other maturities are calculated by interpolation. </li></ul>
  6. 6. The typical shape of a Yield Curve
  7. 7. Now… <ul><li>Yield curves are usually upward sloping i.e. the longer the maturity, the higher the yield, with diminishing marginal growth (which means that after a point every increase in duration will bring lesser incremental return). </li></ul>
  8. 8. This is because… <ul><li>It is easier to predict the near term as against the long term. </li></ul><ul><li>Hence, short term papers are usually held by the investor till its maturity. </li></ul><ul><li>And long term instruments are usually traded in the market as their returns get affected by changes in interest rates, which occur regularly in an economy. </li></ul>
  9. 9. Also… <ul><li>The yield curve can also be flat or even concave in shape where the short term yield is seen to be more than than the long term yield. </li></ul><ul><li>This is being witnessed currently wherein overnight interest rates (call money rates) soared due to the liquidity crunch. </li></ul><ul><li>Yield curves move on a daily basis, reflecting the market's reaction to news. </li></ul>
  10. 10. <ul><li>Hope you have now understood the concept of </li></ul><ul><li>Yield Curve </li></ul>In case of any query, please e-mail [email_address]