Yield Curve
The term structure of interest rates — a graph plotting G-Sec (or swap) yields against maturity from overnight to 40 years. Its shape (normal, inverted, flat, humped) signals the market's collective view on growth, inflation, and RBI policy.
Definition
The yield curve (or term structure of interest rates) is a graphical representation of yields on bonds of identical credit quality across a range of maturities, from the very short end (overnight or 91-day T-bills) to the long end (10, 20, 30, or 40 years). In India, the benchmark yield curve is constructed from RBI-issued Government Securities (G-Secs) and is published daily by FBIL (Financial Benchmarks India Pvt. Ltd.) as the FBIL G-Sec par yield curve. A second widely-used curve is the Overnight Index Swap (OIS) curve, which captures the market's expectations of RBI's repo rate over future periods. Yield curves answer the fundamental question: "How much extra yield does the market demand for locking up capital for longer?"
How it is computed
FBIL constructs the G-Sec par yield curve daily using traded prices from NDS-OM (the RBI's electronic G-Sec trading platform), fitting a Nelson-Siegel-Svensson (NSS) parametric model to bootstrapped zero-coupon yields extracted from traded G-Secs across maturities (3-month, 6-month, 1-, 2-, 5-, 10-, 14-, 20-, 30-, 40-year). The NSS model ensures a smooth, arbitrage-free curve even when on-the-run G-Secs have gaps in tenor coverage. Key output: (1) Par yield curve — yields on hypothetical par bonds at each maturity; (2) Zero-coupon (spot) curve — yield for a single cash flow at each maturity; (3) Forward curve — implied future yields between two forward dates (e.g., the 2-year rate 3 years from now). Market practitioners typically refer to the slope as the 10y–2y spread (10-year G-Sec yield minus 2-year G-Sec yield).
Why it matters for investors
The yield curve is the backbone of fixed-income analysis: (1) Monetary policy signal: An upward-sloping (normal) curve indicates the market expects rates to rise or sees adequate term premium — typical in growth periods. An inverted curve (short-end yields > long-end) signals a growth slowdown and potential future rate cuts; the US yield curve inverted in 2022–23, historically a reliable recession predictor. India's G-Sec curve rarely inverts but flattened significantly during 2018–19 and 2021 COVID stimulus. (2) Debt fund duration positioning: Fund managers in Long Duration Funds (SEBI-defined MD > 7 years) take duration risk specifically to profit if the long end of the yield curve rallies (yields fall). (3) Accrual vs. duration strategies: A steep curve rewards "riding the yield curve" — buying a 5-year G-Sec and selling after 1 year as it becomes a 4-year bond at a lower (higher-priced) yield, earning a capital gain on top of coupon income. (4) Corporate bond pricing: Every corporate bond is priced as G-Sec yield (at matching tenor) + credit spread.
Worked example
On a representative trading day, India's G-Sec yield curve (FBIL) shows:
| Tenor | G-Sec Yield | Note |
|---|---|---|
| 91-day T-bill | 6.75% | Conventional "risk-free rate" proxy (academic) |
| 1-year | 6.92% | |
| 3-year | 7.05% | |
| 5-year | 7.15% | |
| 10-year | 7.26% | Benchmark; most-quoted |
| 30-year | 7.55% |
The 10y–2y spread = 7.26% − 6.98% = 28 bps. This is a mildly normal, relatively flat curve — consistent with a late-easing cycle where the market prices in few near-term rate cuts but limited long-term risk premium. A debt fund manager would conclude that adding duration risk (buying 10y vs. 5y) earns 11 bps of additional yield for 5 additional years of maturity — a poor risk-reward in a flat curve environment, favouring shorter-duration accrual strategies.
Caveats
Liquidity distortions: Some tenors (e.g., 7-year G-Sec) may have few traded bonds, causing the fitted curve to interpolate — yields at these tenors are model estimates, not market prices. Parallel shift assumption: Modified Duration assumes the entire curve shifts in parallel; in reality, curves twist and steepen, causing different-maturity bonds to behave differently. Currency effect for NRIs: NRIs investing in Indian G-Secs via RBI's Fully Accessible Route (FAR) must factor USD/INR hedging cost (typically 5–6% annualised), which significantly alters the effective yield curve compared to a domestic rupee investor.
See also
- Yield to Maturity (YTM)
- Modified Duration
- Zero-Coupon Bond
- Credit Spread
- Debt Funds in India — Complete Guide
Primary source
- FBIL G-Sec par yield curve: fbil.org.in
- RBI — Government Securities Market in India: rbi.org.in
- RBI NDS-OM (primary G-Sec trading platform): rbi.org.in/scripts/nds.aspx
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