Yield Curve.

The shape of the yield curve enables security analysts to quickly review and compare yield rates of different types of fixed income securities to determine investor expectations for future market conditions. The slope of the yield curve is influenced by the spread between the yields of different maturities (Burton, Nesiba, & Brown, 2015). As such, the greater the spread the more gentle the slope of the graph.

Table 1: Treasuries

First, it is evident that the yield curve is upward sloping (normal), which suggests that securities with longer maturities have higher returns and vice versa. Intuitively, longer-term securities are associated with greater risk, which implies that they attract higher interest rates. This is why this particular yield curve is considered to be normal. Secondly, the slope is relatively steep because there are small spreads between the yields of different maturities.

Duration

A bond’s duration is a measurement of interest rate risk with regards to its maturity, coupon, yield and call features (Mayo, 2012). Because bond prices are inversely proportional to interest rates, the higher the duration of a bond, the higher the rate at which its price will fall. Consequently, a decrease in the yield to maturity from 8.5% to 8% is associated with a slight decline in the bond’s interest rate risk hence its duration will also decline. Similarly, if the bond gets closer to its maturity then an investor would have to wait a shorter period to redeem the bond hence its interest rate risk will decline. As such, the duration will also decline. Finally, if the market interest rates increase from 8% to 9%, the bond will become less valuable hence the risk inherent in the bond will increase resulting in an increase in its duration.

References

Burton, M., Nesiba, R. F., & Brown, B. (2015). An introduction to financial markets and institutions. New York : Routledge.

Mayo, H. B. (2012). Basic Finance: an introduction to financial institutions, investments and management. Mason, OH: South-Western .