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The yield curve

The Yield Curve. Created by Sal Khan.

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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 US treasuries, and US 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's 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's some treasury debt that's 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 three 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 one year the yield is 3%. Let's do a couple more. Let's say in 10 years-- you're essentially lending money to the treasury for 10 years now-- the annual interest rate on that, let's say it's, I don't know, let's say it's 3.5%. And let's throw one more up here. Let's say if you were to lend money to the US government for 30 years the yield is running at, let's say it's 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 the plot for the US Treasury in dollars, US Treasury bills and bonds. 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 but The Yield Curve, they're talking about US treasuries. So let me draw a yield curve right over here. So on this axis I will put maturity. Let me scroll down a little bit, so maturity. And we have a bunch of different maturities. We have one month. Let's squeeze it, one month. We have three months. And this will be completely to scale. Then we have one year, actually one and three month, 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 one a year. Five years would be like there. I don't have five years, let's do a 10 years. So I'll extend my line over. So one year, maybe 10 years is over here, 10 years. And then you have 30 years. And 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 up 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 and 1/2%. So maybe it'll be like right over there. On one year maturity the yield is 3%. So you plot one year, this is 3%. Let me write it, this is 3% right over here. This is 1.5% right over there. And the first one right over there was 1%. And then at 10 years it's 3 and 1/2%. So 3 and 1/2% is right over here. And we want that to be 10 years. So I'm just plotting that point. And then that 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. I don't want to make it look like-- let me see how well I can draw it. 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're going to get a higher interest than you would for a shorter period of time.