Login with Facebook

The Structure of Interest Rates and the Yield Curve

As you know, the close relationship between bonds and interest rates and how they can rise and fall in certain contexts of the economic cycle. The cost of money, represented by interest rates, is not always the same and changes according to the reference deadline. For example, the yield offered by a one-year bond is different from that offered by the same type of five-year bond.

What is the interest rate curve, and why is it useful for those who want to invest in bonds? Today, in this article, we will discuss the structure of interest rate and the yield curve if you still don't have a clear idea of ​​what it is

What is the term structure of rates?

In a simplified way, we consider bonds of the same investment category (for example, U.S. government bonds) but with different maturities (from 3 months to 30 years). If we combine the points identified by the total return that the investor receives if he keeps the bond until maturity and the time remaining before maturity (residual life 1), we obtain the yield curve or term structure of interest rates.

This curve represents the relationship existing on a given day, according to the market, between the rate of return offered by an American government bond at a specific maturity and the maturity itself.

When you see the chart that shows the yield curve, then you will notice some points.

The first value, the first point of the line, is the spot interest rate, which is the rate for shorter maturity at three months, influenced more directly by the American central bank. Two important aspects when looking at the yield curve are the level of the curve and the shape.

The level of the interest rate curve

The level of the curve and its shifts may reflect the monetary policy behavior of the central bank. Consider the maneuvers of quantitative easing and, in general, of expansive monetary policy by the FED since the outbreak of the Great Recession of 2008. These moves have helped to move down the yield curve, reducing interest rates on the various maturities.

The slope of the rate curve

The slope of the yield curve is influenced by several factors, i.e., expectations, risk premia, and market segmentation/preferences. There are two main explanations for its performance, risk premiums, which investors require to invest in long-term bonds compared to short-term ones, and investors' expectations on future interest rates. These expectations, in turn, reflect what the market expects about:

- price trend

- the trend of the economy

- Central Bank behavior.

In short, the inclination of the curve is not easy to interpret.

Deadline and yield

An interest rate curve is a useful tool not only for market operators but also for individual savers. And expiry and yield are the fundamental elements for tracing the curve in question. We consider bonds of the same investment category (for example, our government bonds) but with different maturities. By connecting the points identified by the total return that the investor obtains if he keeps the obligation until maturity and the time that remains before the same maturity, the term structure of interest rates is obtained; in technical jargon, it is called the yield curve.

The level of the yield curve

The level of the curve and the relative movements, upwards or downwards, mainly reflects the monetary policy decided by the central bank of the reference country. The Quantitative Easing program, for example, launched by central banks to support the economy in the years of the crisis and which continues in most countries, has contributed to "crushing" the yield curve and, therefore to reducing the rates of interest on different deadlines.

The slope of the curve

The curves of interest rates are not all the same and can have different shapes and, therefore, different inclinations. The inclination is influenced mainly by two factors, i.e., the risk premium, which investors require to invest in long-term bonds compared to short-term ones, and expectations on future interest rates, the latter linked to inflation expectations. The possible forms that a curve can take based on the economic context are manifold.

The three types of the yield curve

The yield curve can take three typical forms, which we now analyze.

1: Flat

Short-term rates are approximately equal to long-term rates, which are usually highlighted with a blue line. This form may signal an expectation of a slowdown in economic activity. Such a curve is unusual and generally indicates a transition phase towards a positive or negative inclination.

In most cases, the "red" curve indicated a slowdown in economic activity in the country, and, actually, there is a recession due to a drop in consumption.

2: Negatively inclined

In this situation, as maturities increase, rates decrease that is highlighted with a green line. Financial markets expect short-term rates to be lower in the future. This form is indicative of a recessionary and/or deflationary economic phase and may reflect expansive monetary policy expectations.

Generally, this type of inclination does not last long. At the beginning of 2000, the yield curve was negatively inclined. About a year later, the American economy went into recession; marking the end of the period that Alan Greenspan had called "irrational euphoria."

3: Positively inclined

It is the normal inclination of the curve so that, as the due dates increase, the rates increase, which is usually highlighted with a yellow line. This is because long-term bonds are riskier, it is easy to understand that if an investor deprives of a sum today, he lends it and knows that he will be able to receive it back in many yearsInterest Rates, he will ask for a bigger premium.

The slope of the curve can also be explained by expectations; the financial markets expect higher short-term interest rates in the future. This inclination is indicative of an expansionary and/or inflationary economic phase and may reflect expectations of restrictive monetary policy (increase in interest rates).


Comments





Send Comment

Need a custom
essay?

We will write it for you.
Order now

Free Essay Examples

Free essays:

All you need to know about the epidemiology
Applications of BIOMEMS
All you need to know about metabolic pathways
Application to synthetic biology of CAD methods
Broadcasting: How to Be Good In Front of the Camera
Bioconjugates for the Drugs Delivery
Big data analysis in evolutionary biology
Brain-Computer Interface systems with EEG signals
Current challenges to the health of women
Current challenges to the health of Adolescence
Competitive strategies for modern businesses
Computed Tomography (CT) images and their reconstruction
Doppler ultrasound or simply eco Doppler
DNA extraction
Dynamic Systems Modeling with Machine Learning
Digital Imaging: What Is It?
Everything you need to know about the capital market
Entrepreneurship: Conceptual Framework for Evaluating Technology
Entrepreneurship: Opportunity and Design Thinking
Everything you need to know about enzymatic kinetics
Factors about The Savings Investment Process
Financial intermediaries and its Types
Fascias: all about fibrous membranes
Funding sources for non-profit organizations
Genetic regulation networks: modeling in biology
How to make your business survive at economic crisis
How to choose the topic of the senior capstone project
Healthcare technologies that help patients with better self-management
Introduction of Microfabrication techniques
Introduction to Writing a TV Script
Introduction to Journalism
Importance of modern trade policy
Journalism: What is News?
Journalism: Broadcast media and Television Presenters
Journalism: Sources of News
Journalism and Law
Kinetic models in biology and Related fields
Know about the different forms of traditional African dances
Know about the history of science
Latest technology trends
Microfluidics and microfluidic chips
Molecular Imaging
Modern conservatism in America
Modeling and simulation of genetic regulatory networks
Nanomedicines to target tumors
Nonlinear Dynamics in Biology & Biomedicine
NLS (Nonlinear System) - Revolutionary system in diagnostic medicine and therapy
Neural networks: what they are and what they are for
Overcoming Hiring Challenges for Nonprofit Organization
Principle of Optical coherence tomography (OCT)
Politics and Religion: Relations and Conflict Issues
Principle and parameters of Volumetric computed tomography
Role of technology in the modern business environment
Role of Homeostasis in Human Physiology
Role of a digital artist
Role of gender studies
Skills in Journalism: Effective Interview
Systems biology - An understanding the functioning of biological systems
Self-assembly for biological systems
School of American Ballet
The Structure of Interest Rates and the Yield Curve
The New Media: Emerging Trends
The technical basis of optical coherence imaging
The Principles of MRI Contrast agents
Ultrasound: physical principles and image formation
Understanding social entrepreneurship
Understand the importance of investigative journalism
Urban planning in the US
Various theoretical perspectives of sociology
Virtual reality, what it is and how it works
What is transition elastography?
What is lithotripsy and its types?
4 Facts about Origin of Mathematics!
5 techniques to create an animation
13 Best colleges for political science in the world
3d Model Of Building
All you need to know about the ACA Code of ethics
Architecture and Democracy: An Introduction
Architecture and Democracy: Democratic Values
Architecture and Democracy: Democratic Procedures
All You Need to Know About a Synthesis Essay
An essential guide to understanding Film Theory
Application of Artificial Intelligence in Cyber Security
Applications of electrical engineering
Augmented reality: what it is, how it works, examples
Advantages And Disadvantages Of Social Networking
All you need to know about Cryptography
Applications of astrophysical science
All you need to know about architecture engineering
Applications of geological engineering
Artificial intelligence and medicine: an increasingly close relationship
An insight into Computational Biology
ACA code of conduct
A Rose for Emily
Applications of Mathematics in daily life
Architecture mistakes to avoid
All you need to know about Toxicology
All you need to know about Holistic Medicine
All you need to know about linguistics
An introduction to Linguistics and its subfields
All you need to know about Anxiety disorder
All you need to know about Drones
A Brief Insight into Political Science
Assumptions related to feminism
All you need to know about Byzantine emperors
All you need to know about labour economics
An insight into xenobots -the first-ever robots
An ultimate guide about Biomaterials
A Comprehensive Introduction to the Mona Lisa
Analysis methods of Transport through biological membranes
An ultimate guide about biochemical reactions
Analysis of brain signals
Artificial Gene Synthesis
Application to synthetic biology of CAD methods
All you need to know about metabolic pathways
Applications of BIOMEMS
All you need to know about the epidemiology
How to Write a Personal Essay
Housing Needs in America
How to Write a Description Essay
How to Create an Excellent Scholarship Essay?
How to write a cause and effect essay
How to Hire the Best Essay Writing Service Provider?
How to Write a College Application Essay?
How to get the most out of your English lectures
How to write Expository Essay
How to succeed in your psychology class?
How to Write an Academic Essay in the Shortest Time?
History of Journalism
How Different Sectors are Using Artificial intelligence (AI)
How to write an informative essay
How to deliver persuasive essays?
How to Give a Convincing Presentation
How to write an essay on leadership?
Historical Art Still Around Today
Humanoid robot: what it is, how it works and price
History of Chemistry
Healthcare Advanced Computer Power: Robotics, Medical Imaging, and More
Healthcare AI: Game Changers for Medical Decision-Making and Remote Patient Monitoring
How to understand different types of English
How to Cope with Chronic Pain
How African American choreographers and dancers have influenced American dance
How mobile robot can do in logistics or in production
How To Become a Successful Entrepreneur
History of the Philosophy of Feminism
How is the climate changing?
How to Track Your Content Marketing ROI
How to Gun control In the USA?
Historical and contemporary role of labour in the modern world
How breast cancers are classified?
How the cells of our body communicate?
How the Lymphatic System Works?
How Digestive System Works
How to complete your capstone projects effectively?
How to write a research project
Healthcare technologies that help patients with better self-management
How to choose the topic of the senior capstone project
How to make your business survive at economic crisis
The Looming Energy Crisis in America
Top benefits of performance-based engineering
The More Languages You Know, The More Times You Are a Man
Things to consider while writing an Argumentative Essay
Top Ways to Improve Your Academic Writing Skills
Tips to Excel in Creative Writing
The origins of films in the early 19th century
Top career options in Architecture
The Elevator Pitch
Top finance trends 2020
The basic Structure and functionality of robots
The Way to Success
The election system of the President in the United States of America
Two-party System in United States of America
Top trends in urban design
The history and theory of African American filmmaking
Top benefits of creative writing
Tinnitus Guide: Common Symptoms and Treatment Options
The language of dance
The digital image processing management
Top famous politicians of the World
Top methods of political science!
The history of the feminist movement
The blood flow in cardiovascular system - Biofluid Mechanics
The best of Leonardo Da Vinci
The Structure and Function of Macromolecules
The structure of cell: a research on the bricks of the human body!
Tissue and organ construction: Adhesion and recognition between cells
The kinetics of the transformation processes
The Modeling of Biological Systems
Tips for writing a great thesis statement
The Defense mechanisms against infections
The impact of the technological innovations in medicine
Top journalism trends to know about
The relation between mass media & politics
Theranostics: Diagnosis and Care through Nanoparticles
The practical Applications of X-rays
The applications of Ultrasound in medicine
Transfer mechanisms of genetic information in Bacteria
The regulation of cellular metabolism in the diagnosis
The Principles of MRI Contrast agents
The technical basis of optical coherence imaging
The New Media: Emerging Trends
The Structure of Interest Rates and the Yield Curve
What is a Definition Essay?
What are diagnostic essays?
What is the relation between art structural engineering?
What is a Narrative Essay
What are robotics and intelligence systems?
What are the benefits of studying health sciences?
What is artificial intelligence and why it matters?
What is comparative Literature?
Why study neuroscience
What is Wi-Fi and how does it works
What is French history famous for?
What are Humanistic Studies?
What is covered in Biophysics?
What is modern journalism?
What is Virtualization? Benefits & Applications
What are modern public relations?
What is plasma physics?
What is teacher preparation?
What is rapid prototyping for 3D printing?
What is contemporary European Politics?
Why should you learn American Ballet?
What is engineering physics?
What is the purpose of African American Literature?
Ways to learn the Rhythm
What is digital art used for?
What are Enzymes and how do they work
Who is the father of political science?
Why Study Political Science - Job?
What is the Philosophy of Feminism?
What is a quantum computer?
Ways B2B Startups Streamline Their Conversion Strategies
Why do biomedical signals need processing?
What are the long term effects of climate change?
Why study labour relations
What is Holoprosencephaly?
What is antisocial disorder?
What are the important principles of evolution?
What is the cytoplasm and its function?
What is biopolymers?
What Makes a Good Leader
Women empowerment in modern generation
What is the history of political thought?
What is Gene recombination
What is synthetic biology
What is business cost analysis?
What is Inflation
What are the consequences of unemployment?
What is lithotripsy and its types?
What is transition elastography?