I work in quite a niche job, I work for one of the largest investment banks worldwide and I work in the interest rates asset class.
As a subsection of Rates, I only work with exotic products, i.e complex over-the-counter derivatives as opposed to vanilla exchange-traded products. As such I have built up some detailed knowledge of the financial markets, derivative product offerings and how to value them.
Two concepts I want to cover in this post which I hope you will find useful.
Treasury Bonds
Treasury Bonds (aka T-bonds for short) are a type of fixed interest debt security.
The most well known T-bond is the USD treasury bond. This is effectively debt issued by the USD government. The debt will generally be issued with the following characteristics:
Notional - i.e the amount of money you are loaning the US government
Maturity date - length of time before the notional is returned to you
Coupon - interest payment that you receive while you are loaning your money
Now understanding a basic fixed-interest rate security allows us to understand an additional concept:
Yield Curve
A yield curve is a plot of yields of a certain type of fixed-interest security against various maturities. Now people talk about yield curves a LOT and they are very key to market based commentary.
The blue line I've drawn represents a flat yield curve, i.e a 3 year T-bond will pay the same coupon annually as a 30 year T-bond.
But in reality this is rare, as it implies there is no time cost of money. Simply put, if you were to loan me $100 and I agreed to pay you $5 a year in interest, would you mind if I paid you back in 1 year or 30 years?
Most people would want their money back sooner, hence we typically see a yield curve that resembles the red line. I.e people expect a higher coupon payment if their money is going to be kept from them longer.
So what can we use yield curves for?
Well they are a good indicator of the current market consensus towards future projected interest rates. A flattening of the yield curve implies that one of two things have happened:
- long term rates have fallen
- short term rates have increased
Both of these can have major ramifications for the state of the economy and the Fed's use of monetary policy.
I hope you found this useful, this was merely a brief introduction into some basic interest rate concepts, if you have any questions please fire away in the comments below. Additionally if there are any topics you want covered, please let me know!