The Treasury Yield Curve

The relationship between yield and maturityof

on-the-run Treasury securities is displayed in the
following table. The relationship shown is called
theTreasury yield curve—even thoughthe
‘‘curve’’ shown is presented in tabular form.
Issue (maturity) Yield (%)
1 month 1.68
3 months 1.71
6 months 1.81
1 year 2.09
2 years 2.91
5 years 4.18
10 years 4.88
30 years 5.38
The information presented indicates that the
longer the maturity the higherthe yield and is
referred to as an upward sloping yield curve.
Since this is the most typicalshape for the
Treasury yield curve, it is also referred to as a
normal yield curve. Otherrelationships have
also been observed. An inverted yield curve
indicates that the longer thematurity, the lower
the yield. For a flat yield curve the yield is
approximately the sameregardless of maturity.

To get a yield for maturities where no on-the-run

Treasury issue exists, it is necessary to interpolate
from the yield of two on-the-run issues. Thus, when
market participants talk about a yield on the
Treasury yield curve that is not one of theavailable
on-the-run maturities—for example, the 8-year yield
—it is only an approximation.
It is critical to understand that any non-
Treasury issue (e.g. corporate bond) must
offer a premium above theyield offered for the
same maturity on-the-run Treasury
issue.Howmuch greater depends on the
additional risks associated with investing in
thenon-Treasury issue.

Limitations of the yield curve are: the quoted

yields (BEY) may not reflect the true yields
and there exists reinvestment riskand interest
rate riskin case of on-the-run Treasury issues
maturities greater than 1 year.
[The risk that an investor faces ifthe future interest rates go
below the yield to maturity at the time the bond is
purchased, is known as reinvestment risk.
If the bond is not held to maturity, the investor faces the
risk that the bond may have to be sold for less than the
purchase price and resulting in a return that is less than the
yield to maturity, this is known as interest rate risk.

Because of the above problems, when market

participants talk about interest rates in the
Treasury market and use these interest rates to
value securities they look atanother
relationshipin the Treasury market: the
relationship between yield and maturity for
zero-coupon Treasury securities.However,
zero-coupon Treasury securitieswith maturity
greater than one yearare not issued. As such,
government dealers synthetically create zero-
coupon securities – the process is known as
stripping of Treasury securityand thesecurities
are called Treasury strips. Because zero-
coupon instruments have no reinvestment risk,
Treasury strips for different maturities provide a
superior relationship between yield and
maturity than do securities of on-the-run
Treasury yield curve. The yield on a zero-
coupon security has a special name: the spot
rate. In case of a Treasury security, the yield is
called a Treasury spot rate. The relationship
between maturity and Treasury spot ratesis
called the term structure of interest rates.

[The relationship between yield and maturity of on-the-run

Treasury securities is called the Treasury yield curve
The yield on a zero-coupon non Treasury security has a
special name: the spot rate curve.
In case of a Treasury security, the yield is called a
Treasury spot rate curve.]
When the credit spreadfor a given credit rating
and market sector are added to the
Treasuryspot rates, it is called benchmark
spot rate curve.

The lower the credit rating, the steeper the term

structure of credit spreads i.e. the benchmark
spot rate curve.