Riding the Yield Curve

Rolling down the yield curve strategy

The rolling down the yield curve strategy is performed as follows. An investor purchases bonds with a maturity that is longer than his or her investment horizon. In an upward-sloping yield curve environment, longer maturity bonds have higher yields and shorter maturities have lower interest rates. Thus, as the bond approaches expiration, it is valued at successively lower interest rates and thus at successively higher prices.

If, and this is a very important assumption, the yield curve stays unchanged, then the rolling down the yield curve strategy will produce higher returns than the maturity-matching strategy. The greater the difference between the forward rate and the spot rate, the higher the total return.

Riding the yield curve example

Finally, let’s have a look at the riding the yield curve calculation. In particular, let’s look at an investor who pursues such a strategy. The following table provides a hypothetical situation in which an investor buys longer-dated bonds. We used a simple rolling down the yield curve Excel spreadsheet to create this example.

If there is no change in the yield curve over the investment horizon, the investor will earn both a coupon and experience a capital gain. Clearly, such a strategy is not without risk. There is no guarantee that the yield curve will remain unchanged.