RIDING THE YIELD CURVE

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• RIDING THE YIELD CURVE

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Use of Short-term Securities

• Non-financial entities use short-term securities
• Treasuries or similar instruments for which
  Treasuries would serve as a convenient proxy
• Under normal conditions of the yield curve short
  term securities earn lower rates of return than
  long term securities

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NORMAL YIELD CURVE

• Upward sloping
• Inducement to hold long term securities

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Other shapes of the yield curve

• Flat
• Humped
• Downward sloping (reverse)

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RECENT YIELD CURVES Sep 1997, Jan 1998, Sep
1998, Feb 2000
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Riding the Yield Curve

• Means investment in the short term security
  which would yield the highest holding period
  return, regardless of original maturity of the
  security when issued
• Involves investing into an unknown yield
  situation
• Has some risk present

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Investment to Match Holding Period

• You have a holding period of x days
• You buy a security with x days-to-maturity
• Purchase price is known (todays price)
• Selling price is known (100 of face)
• Holding period yield is known for certain,
  regardless of interest market changes

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Investment Longer than Holding Period

• You have a holding period of x days
• You buy a security with x y days-to-maturity
• Purchase price is known (todays price)
• Selling price is unknown (whatever the market
  price will be when you sell)
• If interest rates are stable you can predict the
  selling price and calculate your rate of return

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Riding the Yield Curve

• Buy an x y days-to-maturity security
• Hold it x days
• Sell a y days-left-to-maturity security
• Under a normal yield curve, the holding period
  yield will be higher than if you buy and hold to
  maturity an x day security.