The Money Markets Handbook: A Practitioner's Guide

CHAPTER 6

The Money Market Yield Curve

The main measure of return associated with holding debt market assets is the yield to maturity or gross redemption yield. In developed markets, as well as certain emerging economies, 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 what is known as a yield curve. The yield curve is an important indicator and knowledge source of the state of a debt capital market. It is sometimes referred to as the term structure of interest rates, but strictly speaking this is not correct, as this term 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 capital markets revolves around the yield curve. The yield curve describes the relationship between a particular redemption yield and a bond’s maturity. Plotting the yields of bonds along the 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 the yield curve; for example a curve may be constructed for UK gilts or for AA-rated sterling Eurobonds, but not a mixture of both, because gilts and Eurobonds are bonds from different ...