Trading Educators Blog
Relationships Part 2
Sometimes it pays to understand certain relationships. For some people it seems that understanding the relationships among interest rate bearing instruments is quite difficult
For many traders, as well as for most of the general public, interest rates are intrinsically a subject of little excitement. How often do you find yourself lying awake at night worrying about interest rates? For most of us it is not a matter of much concern.
When demand for money rises, so do market rates; when demand eases, so do rates. But all debt is not the same. Credit risk varies by borrower. Risk associated with lending and opportunity with borrowing vary with time of obligation. Opinion about the latter is reflected in the yield curve, with the market usually compensating the perceived greater risk usually associated with money lent for longer periods of time with a greater yield.
Therefore, debt instruments, though similar, are not the same. They contract for different principles, different yields, different maturities. The public sector issues them at different times, in different places, for different amounts, and with different tax treatment.
In examining the various relationships, we must consider maturity. Maturity has a lot to do with the relationship between municipal bonds (designed for a maturity between 30-year bonds and 10-year notes) and 5-year Treasury notes.