1 00:00:00,000 --> 00:00:00,770 2 00:00:00,770 --> 00:00:01,750 Welcome back. 3 00:00:01,750 --> 00:00:04,780 Before we proceed further and get a little bit better 4 00:00:04,780 --> 00:00:08,000 understanding of why maybe some of these investors were 5 00:00:08,000 --> 00:00:10,330 so keen on investing in mortgage backed securities, 6 00:00:10,330 --> 00:00:13,330 essentially loaning this money to all these people who are 7 00:00:13,330 --> 00:00:16,090 buying these ever appreciating houses, I think we need to a 8 00:00:16,090 --> 00:00:18,110 few more tools in our tool belt. 9 00:00:18,110 --> 00:00:19,910 So I'm going to introduce you to the concept 10 00:00:19,910 --> 00:00:21,710 of the yield curve. 11 00:00:21,710 --> 00:00:22,890 You might have heard this before. 12 00:00:22,890 --> 00:00:25,970 You might have heard people on CNBC talk about it. 13 00:00:25,970 --> 00:00:29,460 And hopefully, after about the next five or ten minutes, you 14 00:00:29,460 --> 00:00:32,600 will know a lot about the yield curve. 15 00:00:32,600 --> 00:00:34,290 So when most people talk about the yield curve, they're 16 00:00:34,290 --> 00:00:35,950 talking about the treasury yield curve. 17 00:00:35,950 --> 00:00:37,930 And what does that mean? 18 00:00:37,930 --> 00:00:39,580 What is even a treasury? 19 00:00:39,580 --> 00:00:42,230 So these treasury securities, whether they're T-Bills, 20 00:00:42,230 --> 00:00:45,445 treasury bills, treasury notes, or treasury bonds. 21 00:00:45,445 --> 00:00:57,010 22 00:00:57,010 --> 00:01:01,130 These are loans to the federal government. 23 00:01:01,130 --> 00:01:04,720 And these are considered risk-free. 24 00:01:04,720 --> 00:01:08,090 Because if you lend to the federal government and they're 25 00:01:08,090 --> 00:01:10,840 running short of cash, all they have to do is increase 26 00:01:10,840 --> 00:01:15,590 taxes on us the people and they can pay back your debt. 27 00:01:15,590 --> 00:01:19,400 So in dollar denominated terms, the treasury bills, 28 00:01:19,400 --> 00:01:22,060 notes, and bonds are about as safe as you can get in terms 29 00:01:22,060 --> 00:01:24,420 of lending your money to anyone. 30 00:01:24,420 --> 00:01:26,540 So when most people talk about the yield curve, they're 31 00:01:26,540 --> 00:01:28,630 talking about the risk-free yield curve. 32 00:01:28,630 --> 00:01:34,260 And they're talking about the curve for treasuries. 33 00:01:34,260 --> 00:01:36,770 So first, a little bit of definitions. 34 00:01:36,770 --> 00:01:40,470 What is the difference between treasury bills, treasury 35 00:01:40,470 --> 00:01:43,480 notes, and treasury bonds? 36 00:01:43,480 --> 00:01:45,790 They're pretty much all loans to the government. 37 00:01:45,790 --> 00:01:48,210 But they're loans for different amounts of time. 38 00:01:48,210 --> 00:01:55,580 So if I give a loan to the government for \$1,000 for six 39 00:01:55,580 --> 00:01:57,500 months, that will be a treasury bill. 40 00:01:57,500 --> 00:02:00,710 So I will give the government \$1,000, the government would 41 00:02:00,710 --> 00:02:02,180 give me a treasury bill. 42 00:02:02,180 --> 00:02:04,340 And that treasury bill from the government is essentially 43 00:02:04,340 --> 00:02:08,229 just an IOU saying that I'm going to give you your money 44 00:02:08,229 --> 00:02:12,740 back in six months with interest. Similarly, if it's 45 00:02:12,740 --> 00:02:15,010 three months, it's a three month treasury bill. 46 00:02:15,010 --> 00:02:19,590 Treasury notes are loans that are from one year to 10 years. 47 00:02:19,590 --> 00:02:24,110 So on this graph that we're going to make using the actual 48 00:02:24,110 --> 00:02:29,060 yield curve rates, from zero to one year-- and actually 49 00:02:29,060 --> 00:02:31,490 there's no zero year treasury bill. 50 00:02:31,490 --> 00:02:34,250 Actually, the shortest one is one month. 51 00:02:34,250 --> 00:02:36,830 This would be something like here on our graph. 52 00:02:36,830 --> 00:02:42,810 So from one month to one year, these are T-bills. 53 00:02:42,810 --> 00:02:46,090 And this is just definitional. 54 00:02:46,090 --> 00:02:49,560 Then from one year to 10 year, these are notes. 55 00:02:49,560 --> 00:02:55,670 Actually, I believe the one year itself is a note. 56 00:02:55,670 --> 00:02:57,440 Up to one year is a bill. 57 00:02:57,440 --> 00:02:58,520 Although, I might be wrong with that. 58 00:02:58,520 --> 00:02:59,490 Correct me if I'm wrong. 59 00:02:59,490 --> 00:03:00,700 That's just a definitional thing. 60 00:03:00,700 --> 00:03:03,950 From one to 10 year, these are called notes. 61 00:03:03,950 --> 00:03:06,850 And then when you go beyond 10 years, these are called 62 00:03:06,850 --> 00:03:09,470 treasury bonds. 63 00:03:09,470 --> 00:03:12,930 These are just definitional things to worry about. 64 00:03:12,930 --> 00:03:15,060 So with that out of the way, let's talk about what the 65 00:03:15,060 --> 00:03:17,840 yield curve is. 66 00:03:17,840 --> 00:03:19,570 I'll just give you a simple thought experiment. 67 00:03:19,570 --> 00:03:24,260 If I'm lending money to someone for a month versus 68 00:03:24,260 --> 00:03:28,020 lending money to that person for a year, in which situation 69 00:03:28,020 --> 00:03:31,080 am I probably taking on more risk? 70 00:03:31,080 --> 00:03:36,040 Well, sure, if I'm lending someone for a month, I know 71 00:03:36,040 --> 00:03:37,870 only so much can happen in that month. 72 00:03:37,870 --> 00:03:41,920 So I would expect to be paid less interest. Not just 73 00:03:41,920 --> 00:03:46,530 obviously in dollar terms, but even adjusted for time, I 74 00:03:46,530 --> 00:03:50,370 would expect less interest for that month. 75 00:03:50,370 --> 00:03:52,410 And this is actually an important point to make. 76 00:03:52,410 --> 00:03:55,880 When I say that I'm charging 6% interest for that month, 77 00:03:55,880 --> 00:03:57,730 that doesn't mean that after a month the person is going to 78 00:03:57,730 --> 00:03:59,650 pay me 6% on my money. 79 00:03:59,650 --> 00:04:03,040 It means that if I were to give that money to somebody 80 00:04:03,040 --> 00:04:04,820 for a month, and they were to pay it back. 81 00:04:04,820 --> 00:04:06,970 And then I were to give that money to, say, that same 82 00:04:06,970 --> 00:04:09,240 person, or another person, for a month, and I were to keep 83 00:04:09,240 --> 00:04:12,770 doing that for a year, then in aggregate I would get 6%. 84 00:04:12,770 --> 00:04:16,310 So that 6%, no matter what duration we talk about, 85 00:04:16,310 --> 00:04:19,550 whether one month, one year, five years, 15 years, when we 86 00:04:19,550 --> 00:04:22,190 talk about the interest rate, that's the rate that on 87 00:04:22,190 --> 00:04:24,160 average we would get for a year. 88 00:04:24,160 --> 00:04:26,440 It's the annualized interest rate. 89 00:04:26,440 --> 00:04:27,740 So going back to my question. 90 00:04:27,740 --> 00:04:30,970 If lend someone money, even the government, for a month, 91 00:04:30,970 --> 00:04:32,870 there's usually less risk in that. 92 00:04:32,870 --> 00:04:34,510 Because only so much could happen in a 93 00:04:34,510 --> 00:04:35,570 month versus in a year. 94 00:04:35,570 --> 00:04:38,190 In a year there might be more inflation, the dollar might 95 00:04:38,190 --> 00:04:42,120 collapse, I might be passing on better investments, I might 96 00:04:42,120 --> 00:04:44,880 need the cash in a year's time, while I have a lot of 97 00:04:44,880 --> 00:04:47,630 confidence that I don't need the cash in a month's time. 98 00:04:47,630 --> 00:04:51,690 So in general, you expect less interest when you loan money 99 00:04:51,690 --> 00:04:55,910 for a shorter period time than a longer period of time. 100 00:04:55,910 --> 00:04:57,645 And so let's draw the yield curve and see 101 00:04:57,645 --> 00:04:58,490 if this holds true. 102 00:04:58,490 --> 00:05:00,830 So I actually went to the treasury 103 00:05:00,830 --> 00:05:04,400 website, so that's treas.gov. 104 00:05:04,400 --> 00:05:05,490 And this is the yield curve. 105 00:05:05,490 --> 00:05:08,000 So they say on March 14, so this is 106 00:05:08,000 --> 00:05:09,860 the most recent number. 107 00:05:09,860 --> 00:05:10,830 And I'm going to plot this. 108 00:05:10,830 --> 00:05:15,520 They say, if you lend money to the government for one month, 109 00:05:15,520 --> 00:05:17,830 you'll get 1.2% on that money. 110 00:05:17,830 --> 00:05:20,740 And remember, if it's \$1,000 it's not like I'm going to get 111 00:05:20,740 --> 00:05:23,830 1.2% on that \$1,000 just after a month. 112 00:05:23,830 --> 00:05:26,320 If I kept doing it for a year, this is an annualized number, 113 00:05:26,320 --> 00:05:27,950 I'll get 1.2%. 114 00:05:27,950 --> 00:05:31,400 And so for three months, I get a little bit less. 115 00:05:31,400 --> 00:05:33,080 And then for six months I get more. 116 00:05:33,080 --> 00:05:35,710 And then it does seem that the overall trend is that I expect 117 00:05:35,710 --> 00:05:39,700 more and more money as I lend money to the government for 118 00:05:39,700 --> 00:05:41,530 larger and larger periods of time. 119 00:05:41,530 --> 00:05:44,490 And this is a little interesting anomaly that you 120 00:05:44,490 --> 00:05:46,610 get a little bit more interest for one 121 00:05:46,610 --> 00:05:47,500 month than three months. 122 00:05:47,500 --> 00:05:51,810 And we'll do a more advanced presentation later as to why 123 00:05:51,810 --> 00:05:56,170 you might get lower yields for longer duration investments. 124 00:05:56,170 --> 00:05:58,195 That's called an inverted yield curve. 125 00:05:58,195 --> 00:06:02,160 So let's just plot this and see what it looks like. 126 00:06:02,160 --> 00:06:03,530 So you saw where I got my data. 127 00:06:03,530 --> 00:06:06,000 So they say for one month I'd get 1.2%. 128 00:06:06,000 --> 00:06:07,030 So this is one month. 129 00:06:07,030 --> 00:06:09,800 It'd be right about here. 130 00:06:09,800 --> 00:06:12,370 Three months I get about the same thing. 131 00:06:12,370 --> 00:06:14,720 For six months I get 1.32%. 132 00:06:14,720 --> 00:06:16,910 Maybe that's like here. 133 00:06:16,910 --> 00:06:20,520 One year, I get one 1.37%. 134 00:06:20,520 --> 00:06:22,460 Maybe it's here. 135 00:06:22,460 --> 00:06:25,880 Five years, I get 2.37%. 136 00:06:25,880 --> 00:06:27,130 So that's maybe like here. 137 00:06:27,130 --> 00:06:30,280 138 00:06:30,280 --> 00:06:31,760 And these aren't all of the durations. 139 00:06:31,760 --> 00:06:34,700 I'm just for simplicity not going to do all of them. 140 00:06:34,700 --> 00:06:37,030 For 10 years, 3.44%. 141 00:06:37,030 --> 00:06:40,850 So maybe that's here. 142 00:06:40,850 --> 00:06:44,410 For 20 years, I get 4.3%. 143 00:06:44,410 --> 00:06:45,870 Like that. 144 00:06:45,870 --> 00:06:50,540 And then for 30 years, I get 4.35%. 145 00:06:50,540 --> 00:06:53,400 So the current yield curve looks something like this. 146 00:06:53,400 --> 00:07:03,480 147 00:07:03,480 --> 00:07:06,140 And so you now hopefully at least understand what the 148 00:07:06,140 --> 00:07:06,830 yield curve is. 149 00:07:06,830 --> 00:07:09,960 All it is, is using a simple graph. 150 00:07:09,960 --> 00:07:12,950 Someone can look at that graph and say, well, in general what 151 00:07:12,950 --> 00:07:17,340 type of rates am I getting for lending to the government? 152 00:07:17,340 --> 00:07:19,710 On a risk-free free basis, or as risk-free as anything we 153 00:07:19,710 --> 00:07:23,280 can expect, what type of rates am I getting when I lend to 154 00:07:23,280 --> 00:07:25,100 the government for different periods of time? 155 00:07:25,100 --> 00:07:26,730 And that's what the yield curve tells us. 156 00:07:26,730 --> 00:07:29,120 And in general, it's upwardly sloping. 157 00:07:29,120 --> 00:07:31,380 Because, as I said, when you lend money for a longer period 158 00:07:31,380 --> 00:07:34,000 of time, you're kind of taking on more risk. 159 00:07:34,000 --> 00:07:36,770 There's a lot more that you feel that could happen. 160 00:07:36,770 --> 00:07:38,020 You might need that cash. 161 00:07:38,020 --> 00:07:40,630 162 00:07:40,630 --> 00:07:41,480 There might be inflation. 163 00:07:41,480 --> 00:07:42,560 The dollar might devalue. 164 00:07:42,560 --> 00:07:44,690 There's a lot of things that could happen. 165 00:07:44,690 --> 00:07:47,120 So the next question is, well, what 166 00:07:47,120 --> 00:07:49,500 determines this yield curve? 167 00:07:49,500 --> 00:07:55,890 Well, when the treasury, the government, needs to borrow 168 00:07:55,890 --> 00:07:59,370 money, what it does is say, hey everyone we need to borrow 169 00:07:59,370 --> 00:08:00,990 a billion dollars from you, because we 170 00:08:00,990 --> 00:08:02,510 can't control are spending. 171 00:08:02,510 --> 00:08:04,920 And they say we're going to borrow a billion dollars in 172 00:08:04,920 --> 00:08:05,960 one month notes. 173 00:08:05,960 --> 00:08:07,490 So this is one month notes. 174 00:08:07,490 --> 00:08:08,790 They're going to borrow a billion dollars. 175 00:08:08,790 --> 00:08:10,370 And they have an auction. 176 00:08:10,370 --> 00:08:14,340 And the world, investors from everywhere, they go in, they 177 00:08:14,340 --> 00:08:16,460 say, well, this is a safe place to put 178 00:08:16,460 --> 00:08:17,850 my cash for a month. 179 00:08:17,850 --> 00:08:21,490 And depending on the demand, that determines the rate. 180 00:08:21,490 --> 00:08:24,800 So if there are a lot of people who want to buy those 181 00:08:24,800 --> 00:08:28,940 one month treasuries, the rate might be a little bit lower. 182 00:08:28,940 --> 00:08:30,290 Does that make sense to you? 183 00:08:30,290 --> 00:08:31,170 Think about it. 184 00:08:31,170 --> 00:08:33,900 If a lot of people want to buy it, there's a lot of demand 185 00:08:33,900 --> 00:08:35,390 relative to the supply. 186 00:08:35,390 --> 00:08:38,840 So the government has to pay a lower interest rate on it. 187 00:08:38,840 --> 00:08:42,159 Similarly, if for whatever reason people don't want to 188 00:08:42,159 --> 00:08:44,630 keep their money in the dollar, they think the U.S. 189 00:08:44,630 --> 00:08:47,860 might default on their debt one day, and not that many 190 00:08:47,860 --> 00:08:51,480 people want to invest in the treasury, then that auction, 191 00:08:51,480 --> 00:08:53,510 the government is going to have to pay a higher interest 192 00:08:53,510 --> 00:08:56,340 rate to people for them to loan money to it. 193 00:08:56,340 --> 00:08:59,310 So maybe then the auction ends up up here. 194 00:08:59,310 --> 00:09:02,230 And similarly, the government does auctions for all of the 195 00:09:02,230 --> 00:09:03,380 different durations. 196 00:09:03,380 --> 00:09:05,150 And duration, I just mean the time period you're 197 00:09:05,150 --> 00:09:06,320 getting the loan for. 198 00:09:06,320 --> 00:09:08,370 So they do it for one month, three months, six months, one 199 00:09:08,370 --> 00:09:10,940 year, two year, three year, et cetera. 200 00:09:10,940 --> 00:09:17,930 Once the government has done that auction-- You give the 201 00:09:17,930 --> 00:09:19,010 money to the government, they give you an 202 00:09:19,010 --> 00:09:20,740 IOU called a T-bill. 203 00:09:20,740 --> 00:09:22,100 Then you could trade it with other people. 204 00:09:22,100 --> 00:09:24,930 And that's going to determine the rate in the short term. 205 00:09:24,930 --> 00:09:26,510 So the government does the auction. 206 00:09:26,510 --> 00:09:29,310 But then after the auction, and a lot of people had 207 00:09:29,310 --> 00:09:32,990 demand, but then a lot of people get freaked out. 208 00:09:32,990 --> 00:09:36,180 And the public markets, when you try to sell that treasury, 209 00:09:36,180 --> 00:09:37,480 will then expect. 210 00:09:37,480 --> 00:09:38,200 a higher yield. 211 00:09:38,200 --> 00:09:39,690 I know that might be a little complicated now. 212 00:09:39,690 --> 00:09:42,510 And I always start to jumble things when I run out of time. 213 00:09:42,510 --> 00:09:45,780 But hopefully at this point you have a sense of what the 214 00:09:45,780 --> 00:09:46,590 yield curve is. 215 00:09:46,590 --> 00:09:48,210 You have a sense of what treasury bills, treasury 216 00:09:48,210 --> 00:09:49,820 notes, and treasury bonds are. 217 00:09:49,820 --> 00:09:52,440 And you have some intuition on why the yield 218 00:09:52,440 --> 00:09:54,180 curve has this shape. 219 00:09:54,180 --> 00:09:56,110 See you in the next video.