15. What is a Yield Curve Video Lecture | Become an Expert: Value Investing - Business Basics

welcome to course to unit 2 lesson 3
what is a yield curve in this lesson we
have two lesson objectives the first one
is to know what a yield curve is and the
second lesson objective is how can I use
a yield curve to predict market behavior
so let's get started when you get into
stock and bond investing everyone wants
to be able to predict the future but in
most cases that's pretty hard to do and
it's pretty much impossible to do but
one of the little tools we have at our
disposal to help analyze where our
current market condition is where it
might be going in the future is a yield
curve so this is a really important tool
that you really got to understand in
order to be a successful stock and bond
investor so what is a yield curve so on
the screen I have a yield curve a
generic yield curve and if you look over
on the left there's the yield and that
goes on your y-axis and you can see it
runs from 1 percent up to 5.5 percent on
this particular graph and all that yield
is is that your interest then as we look
at the bottom on our x-axis
we can see that that's the term and from
the previous lessons that you learn in
course 1 about bonds you learned that
the term is nothing more than the years
until the bond matures until that par
value is repaid to the investor so what
this is is it's a comparison between the
yield and the term so as we look at this
particular chart this is considered a
positive yield curve because it starts
over there with the short term of 1 year
and the yield is this low at about 2.3
percent okay and then as you go further
into the term as you move right across
the chart that yield continues to
increase which naturally makes sense you
you would think that this would be
generally how all yield curves are but
they're not but you would think that as
the term increases the yield that one
would be willing to lend their money at
would also increase so as we look at
this one for one year we we said that
the yield is about 2.3 percent and then
as we
would go clear over to the 30 year mark
we can see that the 30 year mark is
around 5% so if you were going to lend
your money for for 30 years
you would get 5% on your money based off
of this Yoker so you can see how that
changes over time so let's look at
another one so when we look at this
yield curve this is considered a flat
yield curve meaning that if you were
going to lend your money for one year
you would get 5% interest or about 4.9
percent interest on this chart and if
you lent it for 30 years you'd almost
make the exact same yield on your money
which really doesn't make a lot of sense
and you might be wondering why in the
world that would be the case but we'll
discuss that in just a little bit but
right now all you have to really
understand is just how I'm reading these
numbers off the chart so if you are
going to buy a 15 year bond you'd look
at this chart and you go from 15 years
right up until you hit the line and you
can see that you would get a 5% yield
now a chart that's really uncommon the
see is is an inverse yield curve okay
and you can see on this chart if you
were going to buy a bond at one year
term you'd get a 4% yield had a two year
bond it would be a 5% yield and just so
you know it if it's one year it's not
considered a bond it's actually
considered a bill so the crook the
proper terminology is a bill at that
point so but as you go into the duration
you can see how this chart is going down
so the the 30-year bond is below 3.5%
but if you're lending your money in the
short term you're actually making more
so that really doesn't make much sense
but as we discuss further in this lesson
you're understand why and when you'll
see a chart like this which is very very
rare you won't see one like this very
often okay so let's look at where we're
at right now on 11 May 2012 then and
this is a US Treasury yield curve okay
and as we look at this yield curve we
can see in the short-term
look at how low those interest rates are
now this is still the reason that those
interest rates are so low in the
short-term is because the federal
government is trying to spark the
economy get people to get out and spend
because there's still a lot of fallout
from the 2008 crash and we're still
seeing the effects of that in 2012 but
if you look at that one-year mark for
the yield you can see it's it's below
0.5% so that's extremely low as you can
look out for the third year it's only
three percent so that's where we're at
in our current market condition on 11
May 2012 so what's important about those
you curves that yield curve is a
valuable tool that can help you as an
investor understand what the federal
government is trying how they're trying
to steer the economy so when we look at
that yield curve okay we see it flat
let's say the whole yield curve is flat
at 5% like this one right here okay when
we think about how that with the federal
government's thinking they are trying to
slow down the economy at this point
they're making the price of borrowing
money expensive especially for that
person in the short term and in the long
term at 5% because they're trying to
slow down the economy and the forecast
in the long term is exactly the same as
it is in the short term so you're
typically going to see a flat or an
inverse yield curve whenever the economy
is doing well because that's the way
that the Fed is trying to slow down the
economy because they don't want a big
bubble to occur because whenever the
bubble gets too big it pops and we go
into a major recession so the Fed tries
to control that by these two when you
see these two charts that's when the Fed
is trying to slow down the economy now
when the feds trying to create spending
and spark the economy we're going to
have a chart that looks like this okay
in the short term that the money the
borrow is really cheap and when it's
cheap people spend and in the long term
they're they're predicting when you go
out to that 30 years the estimate is
that over a 30 year period the average
yield is probably going to be around 5%
so when we look at
our condition where we're at right now
on 11 May 2012 you can see that the Fed
is still trying to create spending in
our economy by keeping those interest
rates very low even at the thirty-year
it's only at 3% and that's extremely low
and so they still project that we're in
a recession and they're wanting the US
economy to spend more money so when we
calculate the intrinsic value of a stock
in course 2 unit 3 which is the next
unit we'll be using the value found on
the yield curve for the ten-year Federal
note so if we go back to the yield curve
here and we look at the 10-year mark you
can see that we're approximately 1.7 1.8
right in that range for the 10-year
federal note and now that might not make
much sense right now as you're looking
at this chart but when we get into the
next lesson you're going to see how that
applies when we apply it to our
intrinsic value calculator so I'm going
to show you something really neat we're
going to go to the US Treasury gov
website and I have the website listed
there below so if you want to go there
and see what I'm doing here that's
that's the link so here's our chart and
what we're going to do is I'm going to
show you how yield curves changed over
time with the Dow Jones so here's our
chart and what we're going to do is
we're going to go to the website okay so
as you can see I've got the screen split
in half here and I have the US
Department of the Treasury pulled up on
the right hand side and I have the Dow
Jones from 1995 up to 2000 if you don't
remember that era during that time the
economy was going through a boom due to
the internet and so around 2000 we kind
of saw the peak of the internet bubble
and so let's look at how this the
Treasury yield curve looked back at the
beginning of 2000 so you can change the
dates right here so we put in 2000
January the must have been on a weekend
for the zero one zero two so we'll just
use your three here we hit go and
there's our chart so this is what the
yield curve looked like back in 2000 now
it was we
look at this yield back then who is it 6
to 7% as you go clear out to the 30 year
term which is a very high interest rate
that's a great interest rate so you can
see back in 2000 the federal government
they knew darn well what was going on
and you can see a nice flat yield curve
and how they were trying to slow down
the economy with very high interest
rates across the board so let's go ahead
and look at what happened as time
marched on after the year 2000 ok so you
can see that I adjusted the Dow Jones
now it's from 2000 up to 2011 is our
timeframe that we're looking after the
Dow Jones and you can see back in 2000
at the very beginning where we just
pulled up the yield curve chart and we
had a we had a nice normal flat yield
curve chart and it was at a high
interest rate so let's look what
happened when we go into the beginning
of 2001 which would be this timeframe
right here where my mouse is at so let's
go ahead and plug that in let's change
the date to 2001 and click go and as you
can see it's actually starting to get a
little bit inverted which I said before
is very rare so when you see that
inverted yield curve you know that
there's probably something coming down
the pipe where interest rates the the
federal government's anticipating
interest rates going lower which means
they're somewhat predicting a recession
at that point so almost a 6 percent
yield at the three-month bill and as you
go out to the thirty-year it's actually
down the 5.4 so that timeframe was right
here at 2001 right before the 2002 crash
and it wasn't a deep crash but it was
somewhat of a crash back then
so let's look what happened to the yield
curve in 2002 in 2003 whenever it
crashed so here it is for 2002 look at
what that yield curve looks like you can
see that the yield is very low in the
short term and in the long term the
Federal Reserve is predicting that
interest rates will
again over that 30 year period but in
the short-term they've got to keep them
low so let's look at what it looks like
in 2003 where it's still kind of a deep
recession there you can see that it's
even lower so they're trying to spark
that economy so there shows you how the
Federal Reserve is basically showing you
exactly what kind of situation you're in
so let's go ahead and look at the really
deep recession in 2008 and we'll start
at 2006 to see how the yield curve
changes over time so let's go to 2006
and there you go they already they
already saw that the economy had
recovered that yield curve started going
flat and I bet you when we go to 2007
you're going to see that that four
percent to five and a half percent yield
curve is actually going to get higher
because they're going to try to slow it
down so let's go to 2007 and see what
happens so there we go 2007 and we're
right here on this peak okay we go and
you can see that it's even higher it's
up at five percent opposed to where it
was that before and you can see it's
slightly getting inverted in 2007 okay
so let's look at what happened in 2008
that's when they started getting the
crash and you're going to see that the
feds already preparing for it you can
see how you're starting to get that that
positively sloped yield curve and that's
the that's the fed tip in their hat that
there's a recession coming now how deep
the recession nobody knows that or can
predict that but you do know that
there's somewhat of a recession coming
then as we go to 2009 you're going to
see it get pretty drastic here I'm sure
okay yeah almost down the zero percent
on your short terms and then on your
long terms it's still very low rated
three percent so hopefully that gives
you an idea of how to read a yield curve
and how you can use that as kind of a
predictor as to what's coming next and
how the Federal Reserve's basically
telling you how to look at the economy
in the direction that it's going so I
hope that that tool really works out
well for you remember that whenever we
get into the next section where we're
value in stocks we're going to be coming
over here
ten year mark and moving straight up on
this yield curve and reading that value
which for this date and 2009 of January
it was two point four six percent so
let's let's quickly pull up here where
we're at in 2012 and the date is May
okay so let's just go there so if you
come over to the ten year you come up
and it's a one point nine eight percent
so when we get in the next section we're
going to be using around two percent in
order to calculate the intrinsic value
of our stocks so that concludes course
to unit 2 lesson three what is a yield
curve we learned what a yield curve was
and we learned how to use the yield
curve to predict market behavior so I
hope you guys learned a lot in this
lesson and I'll see you in the next
lesson