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The Yield Curve. Created by Sal Khan.
Video transcript
If you were to borrow money for different amounts of time, you could imagine the person lending you the money might charge you a different annual interest rate depending on the perceived risk of having the money out there for that amount of time. And the same thing is true when people lend money to the federal government. So when you think about U.S. Treasuries and U.S. Treasuries that have different maturity - and maturity just means: When is the government going to pay you back - You could imagine that there are different interest rates or there are different yields to maturity on that debt. So if we were to plot it. So let's say that - and I'm just going to simplify here - let's say that there is some Treasury debt that is maturing in one month. And if you look at the price that you would have to pay for that debt versus the amount of money that the Treasury is going to pay you when it matures, you see that the yield there is, let's say it is 1%. Let's say for Treasuries that are maturing in 3 months, the yield is 1.5%. Let's say the Treasuries that are maturing in - I'll just pick some maturity dates here - let's say in 1 year. In 1 year, the yield is 3%. Let's do a couple more. Let's say in 10 years - so if you were to literally, you're essentially lending money to the Treasury for 10 years now - the annual interest rate on that, let's say it's 3.5%. Let's throw one more up here. Let's say that if you were to lend money to the U.S. government for 30 years, the yield is running at 4%. So here we have different yields for different maturities. And if we essentially plot this on a graph, we get ourselves a yield curve. And it's usually called "the" yield curve. When people talk about "the" yield curve they're talking about plot for U.S. Treasury Bills and Bonds in dollars. You can have a yield curve really for any debt instrument - for any corporate bonds or even government securities or corporate securities of other countries. But in general when they talk about "the" yield curve, they're talking about U.S. Treasuries. So let me draw a yield curve right over here. So on this axis I will put maturity. Scroll down a little bit. So, maturity. And we have a bunch of different maturities. We have one month, we have three months - and this won't be completely to scale - then we have one year. Actually, one month and three months, let's just put one month right at the beginning. So one month, then three months is a little bit further out. One year would be right over here. Five years would be, like, there. Five years. Oh, I don't have a five years. Let's do a ten years - so extend my line over. So one year, maybe 10 years is over here, and then you have 30 years. I'll just draw 30 years as far as I can. It's not completely to scale, but it's my best shot. And then we plot the yield for those different maturities. So in one month, you have a 1% yield. So let me do the percentages here. So this is 1%, 2%, 3%, 4%. So on one month maturity, the yield is 1%. On three month maturity, the yield is 1.5%, so maybe it'll be like right over there. On one year maturity, the yield is 3%. So you plot 1 year, this is 3% right over here. This is 1.5% right over there, the first one right over there was 1%. And then at 10 years it's 3.5%. So 3.5% is right over here. We want that to be 10 years, just plotting that point. And then at 30 years, it's 4%. So 4% is what we get at 30 years. And if we connect the dots and draw a curve, we are giving ourselves the yield curve. You have a curve that might look something like that. Just by looking at this yield curve, you see that when you lend money to the Treasury for a longer period of time, you get a higher rate of interest than you would for a shorter period of time.