An Introduction to the Bond Markets

5

Yield Curves

Unlike equity shares, many bond issuers issue a number of different instruments with the same guarantees, where only the entitlement to coupon payments and the maturity date differ. As the prices of similar bonds of the same issuer tend to move in line with each other, investors in the issuer's bonds will invest in the bond or bonds that meet their maturity and coupon requirements best. If one plots the yields on such a collection of bonds against their maturity dates, a yield curve is displayed (Figure 5.1).

Graphs similar to Figure 5.1 can be produced for issuers who have issued a significant number of similar issues. For example, they can be produced for many government issuers (e.g. Canada, France, Germany, Italy, Japan, US, to list just a few) and large supranational and corporate issuers (e.g. European Investment Bank, World Bank, General Electric Capital). Figure 5.1 in fact only shows fixed-rate gilt-edged issues, since the returns are not directly comparable with those of the UK Government's index-linked issues.

A yield curve not only shows the return an investor can get on a bond of a specific maturity but also, especially in the case of domestic government issues, the market expectation of future interest rates. This is because it is assumed that a government, in its own currency, will never default as it can always issue more bonds in that currency, although this may be disastrous from an inflation point of view. How this can be done is discussed below. ...