Analysing and Interpreting the Yield Curve, 2nd Edition

CHAPTER 1The Yield Curve

The main measure of return associated with holding bonds is the yield to maturity (YTM) or gross redemption yield (GRY). In developed markets there is usually a large number of bonds trading at one time, at different yields and with varying terms to maturity. Investors and traders frequently examine the relationship between the yields on bonds that are in the same class. Plotting yields of bonds that differ only in their term to maturity produces the yield curve. The yield curve is an important indicator and knowledge source of the state of a debt capital market.¹ It is sometimes referred to as the term structure of interest rates, but strictly speaking this is not correct, as this expression should be reserved for the zero‐coupon yield curve only. We shall examine this in detail later.

Much of the analysis and pricing activity that takes place in the bond markets revolves around the yield curve. The yield curve describes the relationship between a particular redemption yield and a bond's maturity. We should be aware that the GRY of a bond is only ever the actual yield one receives during the period one holds the bond if certain specific, and generally unrealistic, conditions are met. However, we will leave the discussion of this for later.

Plotting the yields of bonds along the maturity term structure will give us our yield curve. It is very important that only bonds from the same class of issuer or with the same degree of liquidity are used when plotting ...