Yield Risk Curve:
This arises due to repricing mismatches. Though both asset and liability could have a repricing profile, this risk could even then arise if the frequency repricing of each of them is asymmetric. Assume a bank has a long term position of 10 year in a government bond. A matching funding is from a 5 year notes. In case there is any unanticipated shift in the yield curve like steepening of the curve. This would result decline in the value of the assets. Yield and Market have inverse relationship.
Yield Curve:
This is a graphical presentation of the Maturity term & Interest Rates. Maturity is plotted on the X axis and interest rates on the Y axis. This graph depicts the interest rate position at a particular point of time than over a period of time. The yield curve are found in three shapes. They are as follows:
- Ascending (upward sloping)
- Descending (downward slope) and
- Flat or humped.
Ascending (Upward Slope) Curve:
An ascending curve would mean that long term rates are higher than short term rates. This understanding is in line with logical explanation that providers of long term source of funds expect a higher return as there is a risk element attached to long term funding. Such a graph would indicate that the market is expecting the economy to grow. The more steeper is the curve the more faster would be expectations of the market for the economy to improve. Another interpretation of this that the future short term rates is higher than current short term rates.
Descending (Downward Slope) Curve:
A descending curve would mean that long term rates are lower than short term rates. This beats a normal logic of the long term interest rates being higher than short term rates. The explanation is long-term providers of funds would settle for lower yields now if they think rates — and the economy — are going even lower in the future. They would bet that this is their last chance to lock in rates before the bottom falls out. Such a graph would indicate that the market is expecting the economy to contract. The more steeper is the downward curve the faster would be expectations of the market for the economy to contract. Another interpretation of this that the future short term rates is lower than current short-term rates.
Flat or Humped Yield Curve:
To become inverted, the yield curve must pass through a period where long-term yields are the same as short-term rates. When that happens the shape will appear to be flat or, more commonly, a little raised in the middle.Unfortunately, not all flat or humped curves turn into fully inverted curves. On the other hand, you shouldn’t discount a flat or humped curve just because it doesn’t guarantee a coming recession. The odds are still pretty good that economic slowdown and lower interest rates will follow a period of flattening yields.
Well this is the basic information about yield curves. Hopefully you found this very useful. Please let me know your views and feedback.
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