The short-term yield curve is a graph that shows the relationship between the interest rates and the maturity dates of bonds that have the same credit quality but different durations. The interest rate is the amount of money that a lender charges a borrower for lending money. The maturity date is the date when the borrower has to pay back the money. A bond is a type of debt that pays a fixed amount of interest every year until the maturity date.
The short-term yield curve usually focuses on bonds that mature in less than one year, such as Treasury bills, commercial paper, or certificates of deposit. These bonds are considered low-risk investments because they have a short time to maturity and are backed by the government or reputable institutions.
The shape of the short-term yield curve can change depending on the supply and demand of the bonds, the expectations of the investors, and the economic conditions. There are three main types of yield curves: normal, inverted, and flat.
- A normal yield curve slopes upward, meaning that the interest rates are higher for longer-term bonds than for shorter-term bonds. This indicates that the investors expect the economy to grow and the inflation to rise in the future, so they demand more compensation for lending money for a longer period of time.
- An inverted yield curve slopes downward, meaning that the interest rates are lower for longer-term bonds than for shorter-term bonds. This indicates that the investors expect the economy to shrink and the inflation to fall in the future, so they are willing to accept less compensation for lending money for a longer period of time. An inverted yield curve is rare but often signals a recession or a financial crisis.
- A flat yield curve shows little difference in the interest rates for different maturity dates. This indicates that the investors are uncertain about the future direction of the economy and the inflation, so they do not have a clear preference for lending money for a short or a long period of time.
The short-term yield curve is an important tool for financial analysts, policymakers, and investors because it can help them to predict the future changes in the interest rates, the economic activity, and the market sentiment. For example, if the short-term yield curve shifts from normal to inverted, it may suggest that the investors are losing confidence in the economy and are expecting a downturn. This may affect the borrowing and lending decisions of the businesses and consumers, as well as the monetary policy of the central bank.
Basic Theory:
The short-term yield curve typically shows how interest rates vary for securities with maturities ranging from overnight to one year. Normally, the curve slopes upwards, indicating that longer-term securities carry higher interest rates due to increased uncertainty and risk.
Procedures:
- Data Collection:
- Gather data on government bond yields with various maturities (e.g., 1 month, 3 months, 6 months, 1 year).
- You can obtain this data from financial news websites, central bank reports, or financial databases.
- Create an Excel Table:
- Input the collected data into an Excel table with two columns: one for maturity periods and another for corresponding yields.
- Plotting the Yield Curve:
- Select the data table and use the “Insert” tab to create a scatter plot.
- Label the horizontal axis with maturity periods and the vertical axis with yields.
- Curve Fitting:
- Use Excel’s trendline feature to fit a curve to the data points.
- Right-click on a data point on the chart, select “Add Trendline,” and choose the appropriate type (e.g., linear, polynomial).
- Interpretation:
- Analyze the shape of the curve. An upward-sloping curve suggests increasing interest rates with maturity.
Scenario:
Let’s consider the following scenario:
- Maturity (months): 1, 3, 6, 12
- Yields (%): 1.5, 1.8, 2.2, 2.5
Calculation:
- Input the scenario data into an Excel table.
- Create a scatter plot and fit a trendline.
- Interpret the curve to understand the short-term yield dynamics.
Excel Table:
| Maturity (Months) | Yields (%) |
|---|---|
| 1 | 1.5 |
| 3 | 1.8 |
| 6 | 2.2 |
| 12 | 2.5 |
Result:
Upon creating the short-term yield curve for the scenario, we observe an upward slope, indicating that yields increase with maturity. This suggests that investors demand higher returns for holding longer-term securities.
Other Approaches:
- Interpolation Techniques:
- Excel offers various interpolation functions like LINEST, TREND, or even custom formulas to estimate yields for non-specific maturity periods.
- Advanced Curve Fitting:
- Consider polynomial or exponential trendlines for a more accurate representation of the short-term yield curve, especially when dealing with complex market conditions.
