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Yield Curves: Part I

by on November 14, 2013 2:05 am BST
 

There is a strong correlation between the FX and bond markets because currencies are close tied and trade off of interest rates. Understanding the marco-perspectives can provide an advantage to your analysis. So, it would be prudent to understand what the basics of a yield curve is.

A yield curve is derived from the annualized yields-to-maturity of government bonds within the same country across all maturities. This is the annualized interest rate paid out when interest is compounded. The yield curve is either positive, neutral or negative sloping.

 

Positive Yield Curve, provided by Financetrain

Positive Yield Curve, provided by Financetrain

Neutral or Flat Yield Curve, provided by Financetrain

Neutral or Flat Yield Curve, provided by Financetrain

 

Negative Yield Curve, provided by Financetrain

Negative Yield Curve, provided by Financetrain

These slopes indicate the yield corresponding to the far-dated maturities. The yield will be located by the Y-axis, while the maturity is located on the X-axis. A positive yield curve shows that yields increase outward, thus the 3Y note will have a lower yield than a 10Y note, and the 10Y note will have a lower yield than a 30Y bond. A negative yield curve means that yields are higher on close-maturing debt than longer-dated debt. A neutral or flat yield curve is where the yield through all maturities are the same.

Yields father out on the curve are typically higher because the lender faces increased risk over time thus receives a higher yield.

Yield Curves: Part II will cover the expectations of yield curves and how they relate to the economy.