G-Sec Yield Curve: Reading the Term Structure

What Is a Yield Curve and How Is It Built for Indian G-Secs

Before diving into interpretation, it is worth being precise about construction. A yield curve is not simply a plot of coupon rates. It is a plot of yields to maturity (YTM) - the total annualised return an investor would earn if they bought a security at its current market price and held it until it matured, receiving all coupons along the way. Coupon rates are fixed at issuance; yields fluctuate continuously as market prices change. This distinction is fundamental.

In India, the raw material for the G-Sec yield curve comes from actual traded prices on the Negotiated Dealing System – Order Matching (NDS-OM) platform, which is operated by the Clearing Corporation of India (CCIL) under RBI oversight. NDS-OM is the primary electronic trading platform for government securities in India, and it generates a continuous stream of price and volume data. From these prices, YTMs are calculated for each traded security using standard bond mathematics. The Financial Benchmarks India Pvt. Ltd. (FBIL) publishes official reference rates and yield curves daily, and the RBI itself publishes G-Sec yield data on its website.

However, at any given point, there are dozens of G-Sec issues outstanding - each with its own coupon, maturity date, and liquidity profile. If you simply plotted all their YTMs against maturity, you would get a scatter plot rather than a smooth curve. This is where curve-fitting comes in. Financial practitioners use mathematical models - the most common being Nelson-Siegel or Nelson-Siegel-Svensson - to fit a smooth curve through the data points, producing what is called the zero-coupon yield curve or spot rate curve. This smoothed curve is more analytically useful because it removes the distortions caused by different coupon rates across bonds.

The Indian G-Sec market covers a remarkably wide range of maturities. At the short end, you have Treasury Bills maturing in 91 days, 182 days, and 364 days. At the medium end, there are dated securities maturing in 2, 3, 5, 7, and 10 years. At the long end, the government has issued securities stretching out to 30 and even 40 years. Each of these data points contributes to the shape of the curve. Importantly, liquidity varies enormously across this spectrum. The 10-year benchmark G-Sec is by far the most actively traded, with tight bid-ask spreads and deep markets. Thirty-year bonds, by contrast, tend to be much less liquid, and their yields can contain a liquidity premium that complicates clean interpretation.

SEBI regulates the participation of various entities in the securities markets, while the RBI regulates the G-Sec market specifically under the Government Securities Act, 2006. Primary Dealers - a group of institutions authorised by RBI - are obligated to make two-way quotes in G-Secs, which helps maintain liquidity and contributes to meaningful price discovery across the curve. Understanding this market structure helps you appreciate why the data underlying the yield curve is generally reliable, though it should always be interpreted in the context of prevailing market conditions rather than treated as a perfect oracle.

The Four Classic Shapes of the Yield Curve and What Each Signals

The yield curve is not static. It shifts, steepens, flattens, and inverts over time in response to changing economic conditions, monetary policy, and investor sentiment. Recognising these shapes and understanding what each typically signals is the core skill of yield curve analysis.

The Normal (Upward-Sloping) Curve is the most common shape and the one most people intuitively expect. In a normal curve, short-term yields are lower than long-term yields - so the line slopes upward from left to right. For example, the 91-day T-Bill might yield 6.5%, the 5-year G-Sec 7.0%, and the 10-year G-Sec 7.3%. This shape reflects two things: first, investors demand a higher return for lending money over a longer period because they are taking on more risk (inflation risk, liquidity risk, duration risk); and second, the market generally expects the economy to grow and interest rates to either stay stable or rise modestly over time. In India, a normal yield curve is broadly associated with a stable monetary policy environment, moderate inflation, and healthy economic growth expectations.

The Steep Curve is an exaggerated version of the normal curve where the spread between short-term and long-term yields is unusually wide. When the 10-year minus the 2-year spread widens significantly - say, beyond 150 basis points - the curve is considered steep. A steep curve often signals one of two things: either the economy is emerging from a slowdown and markets expect the RBI to cut short-term rates further (making short-end yields fall relative to long-end), or there is significant concern about future inflation that is pushing up long-term yields even as short-term rates remain suppressed. During the aftermath of the COVID-19 pandemic in India, the curve steepened notably as RBI held the repo rate near record lows while long-term yields reflected concerns about higher government borrowing.

The Flat Curve occurs when there is very little difference in yield across maturities - when a 2-year G-Sec yields roughly the same as a 10-year G-Sec. Flattening often happens as a transition state: either the central bank is raising short-term rates while long-term inflation expectations remain anchored (bear flattening), or the market expects a slowdown and is bidding up long-term bonds to lock in current yields while short-term rates remain elevated (bull flattening). A flat curve is often interpreted as a sign that markets believe the current monetary policy cycle is nearing its peak.

The Inverted Curve is the most dramatic and most watched shape. In an inverted curve, short-term yields exceed long-term yields - the line slopes downward. Inversion typically signals that markets expect significant rate cuts in the future, usually because economic conditions are expected to deteriorate. In the United States, yield curve inversion has preceded every recession since the 1970s, making it a widely watched leading indicator. India's G-Sec curve has inverted at various points too, though the relationship between inversion and economic weakness is less mechanical in India because the RBI's liquidity management and the captive demand from banks (Statutory Liquidity Ratio, or SLR requirements) can distort the curve somewhat.

There is also a fifth shape worth noting: the Humped Curve, where medium-term yields are higher than both short-term and long-term yields. This shape occasionally appears during periods of transitional monetary policy uncertainty. Beyond these classic shapes, practitioners also talk about curve shifts - a parallel shift occurs when yields at all maturities move up or down by roughly the same amount, while a twist occurs when one end of the curve moves differently from the other. These nuances matter for portfolio management, as we will explore in later sections.

The Three Major Theories That Explain the Yield Curve

Why does the yield curve take the shapes it does? Economists have developed several theories to explain the term structure of interest rates, each capturing a different dimension of reality. Understanding these theories does not just satisfy intellectual curiosity - it directly informs how you should interpret yield curve movements.

The Pure Expectations Theory is the most elegant and the most useful starting point. It states that long-term yields are simply a geometric average of expected future short-term yields. In other words, if you invest in a 10-year G-Sec today, you should earn approximately the same as if you repeatedly invested in 1-year T-Bills over the same 10 years - otherwise arbitrageurs would exploit the difference. Under this theory, an upward-sloping curve implies that markets expect short-term interest rates to rise in the future, while an inverted curve implies expectations of falling rates. The pure expectations theory is intellectually satisfying because it gives the curve a direct forecasting role. However, it has a significant weakness: it assumes that investors are indifferent between holding a single long-term bond versus rolling over a series of short-term ones. In practice, they are not.

The Liquidity Preference Theory, developed by John Hicks, modifies the pure expectations theory by adding a term premium. Most investors prefer liquidity and would rather hold short-term securities because long-term bonds expose them to greater price volatility (interest rate risk). To compensate them for this risk, long-term bonds must offer a higher yield - a liquidity premium or term premium - even if expected future short-term rates are unchanged. This theory explains why yield curves tend to slope upward on average, even in the absence of expectations of rising rates. In India, institutional investors such as insurance companies and pension funds with long-duration liabilities have a natural demand for long-term G-Secs, which can compress the term premium at the long end, particularly for 30 and 40-year bonds.

The Market Segmentation Theory takes a very different approach. It argues that the bond market is effectively divided into distinct maturity segments, each with its own supply and demand dynamics that are largely independent of other segments. Under this view, short-term yields are determined by the supply and demand for short-term funds (influenced heavily by RBI's liquidity operations and T-Bill issuances), medium-term yields by the demand from mutual funds and corporate treasuries, and long-term yields by insurance companies, provident funds, and pension funds that must match long-duration liabilities. This theory helps explain why the Indian yield curve sometimes behaves in ways that pure expectations theory cannot account for - for example, long-term yields staying stubbornly high or low even as short-term rates move in the opposite direction.

The Preferred Habitat Theory is a synthesis of the previous two, suggesting that investors do have preferred maturity ranges (habitats) but will venture outside those ranges if the yield differential is sufficiently attractive. This is probably the most realistic description of how participants in the Indian G-Sec market actually behave. Banks, for instance, hold large quantities of medium-term G-Secs to meet SLR requirements, but they may shift toward shorter maturities when they expect rate hikes, and toward longer maturities when they anticipate rate cuts - but only if the yield pickup justifies moving out of their preferred zone.

For practical purposes, the most useful frame is a combination of expectations theory and term premium. When the curve steepens dramatically, ask whether it reflects rising rate expectations or widening term premiums. When it inverts, check whether it is driven by unusually high short-term rates (tight monetary policy) or unusually low long-term yields (strong growth pessimism). The answer matters for how you should position your fixed-income portfolio.

Key Yield Curve Metrics: Spreads, Forward Rates, and the Break-Even

Reading the yield curve is not just about looking at its shape visually. A set of specific quantitative metrics makes the analysis more precise and comparable over time. These metrics are widely used by traders, economists, and portfolio managers in India and globally.

The most commonly tracked spread in Indian markets is the 10-year minus the 2-year G-Sec spread, often simply called the 10-2 spread. When this spread is positive, the curve is normal; when it turns negative, the curve is inverted. Historically, the 10-2 spread in India has ranged from deeply negative in periods of extreme monetary tightening to over 200 basis points during loose monetary policy phases. A related measure is the 10-year minus the 91-day T-Bill spread, which is preferred by some analysts because T-Bill yields are more directly controlled by RBI's policy rate, making this spread a cleaner measure of the curve's steepness relative to the policy stance.

Forward rates are another crucial tool derived from the yield curve. A forward rate is the implied future yield for a given maturity embedded in today's yield curve. For example, if the current 1-year yield is 6.8% and the current 2-year yield is 7.1%, you can calculate the 1-year forward rate one year from now. The calculation uses the principle that investing for 2 years at the 2-year spot rate should be equivalent to investing for 1 year at the 1-year spot rate and then reinvesting for a second year at the then-prevailing 1-year rate. The formula is: (1 + Y2)^2 = (1 + Y1) × (1 + F1,1), where F1,1 is the 1-year forward rate one year hence. Forward rates are particularly useful for assessing whether the current yield curve already prices in expected RBI rate actions. If the RBI is expected to cut rates by 50 basis points over the next year but the forward curve already implies a 60-basis-point cut, the market has priced more easing than the base case, potentially limiting gains from buying duration.

Break-even inflation rates can be derived when both nominal G-Secs and inflation-indexed bonds (Capital Indexed Bonds or CIBs in India) are available for the same maturity. The difference between the nominal yield and the real yield on an inflation-indexed bond of the same maturity gives you the market's implied inflation expectation - the break-even rate. If the 10-year nominal G-Sec yields 7.3% and the 10-year inflation-indexed bond yields 2.1%, the market is implying average inflation of approximately 5.2% over the next decade. This is a powerful cross-check on RBI's inflation projections and on your own portfolio assumptions.

Roll-down return is a concept that matters especially for active bond traders. If the yield curve is upward sloping and remains stable, a bond's yield will mechanically fall as it ages - because a 9-year bond is cheaper to yield the same as a 10-year bond, all else equal. This yield decline translates into a price appreciation, called roll-down return, which is separate from any directional view on interest rates. In India, the steep section of the yield curve between 5 and 10 years often offers attractive roll-down returns, which is why insurance companies and actively managed bond funds gravitate toward this segment.

How the RBI Uses and Influences the Yield Curve

The Reserve Bank of India has a complex and active relationship with the G-Sec yield curve. As the issuer's banker - the entity that manages the government's market borrowing programme - RBI has both a financial interest in keeping borrowing costs manageable and a monetary policy interest in using the yield curve as a transmission channel for its policy stance.

RBI's primary tool for influencing the short end of the yield curve is the repo rate - the rate at which it lends short-term funds to banks. When RBI raises the repo rate, it directly pushes up overnight and short-term money market rates, which quickly feed into T-Bill yields and the shorter end of the G-Sec curve. However, RBI's influence over the long end of the curve is less direct and more contested. Long-term yields are driven by market expectations of future policy rates, inflation, fiscal deficits, and global factors - all of which RBI can influence but not control.

Operation Twist is one of the most dramatic tools RBI has used in recent memory to directly shape the yield curve. Borrowed from the US Federal Reserve's playbook, Operation Twist involves RBI simultaneously buying long-term G-Secs (to push down long-term yields) and selling short-term T-Bills (to absorb liquidity and prevent short-term yields from falling too much). By doing this, RBI can actively flatten or reshape the curve to support credit transmission - if long-term yields are elevated because of supply concerns or risk aversion, Operation Twist can bring them down without changing the policy rate.

Open Market Operations (OMOs) more broadly are a regular tool. When RBI buys G-Secs outright through OMOs, it injects liquidity into the system and exerts downward pressure on yields across the curve. The size, frequency, and maturity profile of OMO purchases all send signals to the market about RBI's comfort level with prevailing yield levels. During periods of heavy government borrowing - which has been a structural feature of India's fiscal landscape - OMOs have often been used to prevent a sharp rise in yields that might crowd out private investment.

Variable Rate Repo (VRR) and Variable Rate Reverse Repo (VRRR) auctions manage day-to-day liquidity in the system. When the banking system has excess liquidity, short-term rates can fall well below the repo rate; when there is a liquidity deficit, they can rise above it. RBI uses these tools to keep short-term rates within the policy corridor (between the reverse repo/SDF rate at the bottom and the Marginal Standing Facility rate at the top). Significant deviations in systemic liquidity can cause the short end of the yield curve to detach from the policy rate, which complicates the curve's interpretation.

Guidance through communication is increasingly important as RBI has adopted a more transparent monetary policy framework. Statements from the Monetary Policy Committee (MPC), RBI Governor press conferences, and RBI's own published yield expectations in its annual reports and monetary policy reports all shape market expectations and, consequently, the yield curve. In recent years, the MPC's explicit inflation target of 4% (with a ±2% tolerance band) has provided an anchor for long-term inflation expectations that helps stabilise the long end of the curve. Investors watching the G-Sec yield curve should track RBI communications carefully, as forward guidance can move yields significantly without any change in the actual policy rate.

The Yield Curve as a Macro-Economic Signal: What Indian Investors Should Watch

The G-Sec yield curve is not just an interest-rate tool; it is a real-time read on the economy's pulse. Investors who learn to integrate yield curve signals into their broader macro-economic framework can make better-informed asset allocation decisions across equity, fixed income, and other asset classes.

Curve steepening as a recovery signal: When the Indian economy is coming out of a downturn, the yield curve typically steepens. The RBI, having cut rates aggressively to support growth, holds the repo rate low. This pins down short-term yields. Meanwhile, long-term yields begin to rise as investors become more optimistic about growth, expect future rate hikes, and demand more compensation for the higher inflation that typically accompanies a recovery. A steeply positive curve, especially after a period of monetary accommodation, has historically been a favourable environment for equities in India - corporate earnings tend to expand in recoveries, and the banking sector particularly benefits from a wide net interest margin driven by a steep curve.

Curve flattening as a late-cycle signal: As the RBI begins raising rates to combat inflation in a mature expansion, the short end of the curve rises faster than the long end. Short-term yields climb toward and eventually above long-term yields. This flattening often occurs in the final phase of a bull market in equities, and it frequently precedes a period of slower economic growth or tighter financial conditions. For fixed-income investors, a flattening curve is a signal to consider shortening portfolio duration - as short rates rise toward long rates, there is limited capital gain to be made by holding long-term bonds, and the risk of further rate hikes makes long-duration portfolios vulnerable.

Inversion and growth concerns: A yield curve inversion in India should not be automatically interpreted as an imminent recession predictor (as it sometimes is in the US context), but it does warrant attention. Indian curve inversions are often driven by specific domestic or global shocks - oil price spikes, currency crises, or sudden tightening by the US Federal Reserve that forces RBI to raise rates defensively. Nevertheless, a sustained inversion in the Indian G-Sec curve is a warning sign that monetary conditions are tighter than growth dynamics warrant, and it typically precedes some degree of economic cooling and, eventually, an RBI rate-cutting cycle.

Global spillovers and the yield curve: India's G-Sec market, while primarily a domestic market, is not immune to global forces. The US Treasury yield is the world's benchmark risk-free rate, and sharp moves in US yields - driven by Federal Reserve policy, US fiscal concerns, or global risk-off sentiment - can move Indian G-Sec yields significantly, particularly at the long end. Foreign Portfolio Investors (FPIs) are allowed to invest in Indian G-Secs (subject to SEBI and RBI limits), and their flows respond to the yield differential between Indian and US bonds. When this differential narrows sharply (either because Indian yields fall or US yields rise), FPI outflows can steepen the Indian yield curve or add volatility to it.

Fiscal deficit and supply pressure: One factor that makes India's yield curve unique is the very large and predictable supply of G-Secs from the central and state governments. Every year, the Union Budget announces a gross borrowing programme running into tens of lakh crores of rupees. When the fiscal deficit surprises on the upside, the market worries about excess supply of bonds, which can push up yields across the curve - particularly at the long end. This fiscal risk premium is a persistent feature of the Indian G-Sec market and partly explains why Indian long-term yields have historically been higher relative to policy rates than in many developed markets.

Reading the Indian G-Sec Yield Curve in Practice: Data Sources and Tools

Knowing where to find accurate, up-to-date Indian G-Sec yield curve data is a practical necessity for any serious fixed-income investor. Fortunately, several reliable public and semi-public sources are available.

The RBI website (rbi.org.in) publishes daily G-Sec yield data, including benchmark yields and historical time series going back decades. The Database on Indian Economy (DBIE), also maintained by RBI, offers extensive downloadable data on G-Sec yields across maturities, making it possible to reconstruct the yield curve for any historical date and study how it has evolved through different monetary policy cycles.

FBIL (Financial Benchmarks India Pvt. Ltd.) is the authorised administrator of financial benchmarks in India, including the FBIL G-Sec Yield Curve. FBIL publishes a daily smoothed yield curve for G-Secs using market-observed prices from NDS-OM. This is the most methodologically rigorous publicly available yield curve for Indian markets and is widely used by the financial industry for valuation and risk management purposes.

CCIL (Clearing Corporation of India Ltd.) publishes daily trading data from NDS-OM, including prices and yields for all traded G-Sec issues. This granular data is used by sophisticated investors to build their own yield curves or to study the liquidity profile of specific securities.

NSE's website lists G-Secs that are traded on the exchange and provides real-time and end-of-day pricing. While the exchange-traded volumes are smaller than the OTC/NDS-OM market, NSE's data is easily accessible to retail investors and can serve as a practical starting point for understanding where yields are trading.

Mutual fund fact sheets published monthly by asset management companies managing gilt funds provide a snapshot of the fund's portfolio YTM and duration, which is a useful indirect read on where active managers are positioning along the yield curve. While this article does not recommend specific funds, tracking the YTM and duration trends across multiple gilt fund fact sheets can give retail investors a sense of how professional managers are reading the curve.

Bloomberg Terminal and Reuters Eikon are the professional-grade tools that traders and institutional investors use for real-time yield curve analytics, but they are prohibitively expensive for most retail investors. Free alternatives such as Investing.com, the money market section of NSE's website, and various RBI-linked portals provide sufficient data for informed retail decision-making.

When reading any yield curve publication, pay attention to whether the curve shown is a par yield curve, a zero-coupon (spot) curve, or a forward rate curve. These are mathematically related but different things. The par yield curve shows the coupon rate at which a bond would be priced at par for each maturity; the zero-coupon curve strips out coupon reinvestment effects; and the forward curve shows implied future rates. Most newspaper charts and RBI publications show the par or yield-to-maturity curve, which is the most intuitive for beginners. For more advanced analysis, accessing the FBIL zero-coupon curve is worthwhile.

Practical Strategies for Retail Investors Based on Yield Curve Analysis

Understanding the yield curve intellectually is only valuable if it translates into better investment decisions. Here is a framework for how retail investors in India can use yield curve analysis practically, while staying within the bounds of prudent risk management.

Assessing the entry point for long-duration investments: One of the most common mistakes retail investors make is buying long-duration bonds or gilt mutual funds at the wrong point in the interest rate cycle. Yield curve analysis helps avoid this. When the yield curve is steeply positive - with 10-year yields significantly above short-term rates - and there are signals that the RBI is near the end of a rate-hiking cycle (inflation approaching the 4% target, growth moderating), the yield curve is telling you that long-term bonds offer both attractive carry and potential capital appreciation if rates fall. This is generally a favourable time to consider increasing duration in your fixed-income allocation. Remember, however, that timing interest rates is difficult even for professionals, and this should be one factor among many in your decision, not the only one.

Using the curve to calibrate between T-Bills, short-duration funds, and gilt funds: Not all fixed-income investors want to take duration risk. If your investment horizon is 6 to 12 months, T-Bills or liquid funds that invest in short-term G-Secs are appropriate regardless of the yield curve shape. If your horizon is 3 to 5 years, understanding where you sit on the yield curve matters more. In a steep curve environment, capturing the yield pickup in the 5 to 7-year segment often makes sense. In a flat or inverted curve, parking money in short-term instruments gives similar yield with far less duration risk - a free lunch of sorts, until the curve normalises.

Yield curve as an equity market signal: While fixed-income investors are the direct users of yield curve analysis, equity investors benefit too. A steeply positive and stable yield curve typically supports equity valuations by providing a low discount rate for earnings, particularly for long-duration growth stocks. A rapidly rising long-end yield compresses equity multiples because the discount rate rises. Conversely, an inverted curve that subsequently steepens (as the short end falls when RBI cuts rates) has historically been a strong leading indicator for an equity market rally - particularly for financials, whose net interest margins benefit from a steep curve.

Understanding government borrowing calendar: RBI and the government announce the G-Sec issuance calendar at the start of each half-year (April-September and October-March). Large issuances can temporarily push up yields in specific maturity buckets, creating tactical entry opportunities. Retail investors with access to RBI Retail Direct can participate in primary auctions of G-Secs at the market-clearing yield without paying brokerage, making these supply-driven yield spikes particularly valuable.

Diversification across the curve: Rather than concentrating all fixed-income investments at one maturity, spreading across the curve reduces interest rate risk. A portion in 91-day T-Bills provides liquidity; a portion in 5-year G-Secs provides moderate yield with manageable duration; a small position in 10-year or longer G-Secs provides inflation protection and capital gain potential in a declining rate environment. This ladder approach - sometimes called a bond ladder - naturally smooths out reinvestment risk and keeps the portfolio responsive to curve movements without requiring precise timing calls.

Risk management: It is important to reiterate that all G-Sec investments carry interest rate risk (also called market risk or duration risk). Even though G-Secs carry zero credit risk (backed by the Government of India), they can lose significant market value if held in a rising interest rate environment. A 10-year G-Sec with a duration of approximately 7-8 years will lose about 7-8% of its market value for every 100 basis point rise in yields. Investors who may need to liquidate before maturity should always match their investment duration to their actual investment horizon, or accept that interim mark-to-market losses are a possibility. SEBI-registered investment advisors and AMFI-registered distributors are available to help retail investors navigate these decisions.

Common Mistakes and Misconceptions When Interpreting the Yield Curve

The yield curve is powerful but frequently misread, even by experienced investors. Awareness of common pitfalls can save you from costly errors.

Mistake 1: Confusing the yield curve with a forecast of certainty. The yield curve reflects market consensus expectations, not guaranteed future outcomes. Forward rates embedded in the curve are not accurate predictors of where rates will actually be - they are the rates implied by today's prices assuming no-arbitrage conditions. In practice, RBI actions, fiscal surprises, oil price shocks, and global events routinely cause actual rates to diverge significantly from what the curve predicted. Use the curve as a probabilistic input, not a crystal ball.

Mistake 2: Ignoring the term premium. A steep yield curve does not necessarily mean the market is pricing in many future rate hikes. Part of the steepness is always a term premium - the extra yield demanded for uncertainty and illiquidity over longer horizons. During periods of fiscal stress in India (high deficit, large borrowing programme), the term premium widens even if rate expectations are unchanged. Conflating a term-premium-driven steepening with an expectations-driven steepening leads to incorrect macro conclusions.

Mistake 3: Applying US yield curve signals mechanically to India. India is not the US. The captive demand from SLR-bound banks, insurance and pension fund regulations mandating G-Sec holdings, RBI's active OMO operations, and the sheer scale of the government borrowing programme all mean that Indian yield curve dynamics can diverge significantly from those in developed markets. The predictive relationship between curve inversion and recession, for instance, is less robust in India than in the US.

Mistake 4: Focusing only on the 10-year yield. While the 10-year yield is the benchmark, fixing your attention solely on it causes you to miss important information at other points. A flattening driven by the 5-year segment moving up, while the 10-year is stable, tells a very different story from a flattening driven by the 2-year moving up. Spread analysis across multiple maturity points gives a richer picture.

Mistake 5: Neglecting liquidity in off-the-run securities. The Indian G-Sec market is highly concentrated in a few on-the-run benchmark securities, particularly the current 10-year benchmark. Off-the-run securities (older issues of similar maturity) can trade at a yield premium of 5-15 basis points purely due to lower liquidity. When building the yield curve or comparing yields across securities, make sure you are comparing bonds of similar liquidity to avoid false signals.

Mistake 6: Ignoring the credit spread context. The G-Sec yield curve is a risk-free curve. Corporate bond yields, State Development Loan (SDL) yields, and public sector undertaking bond yields all trade at spreads above G-Secs. These spreads can widen or narrow independently of the G-Sec curve movement. A falling G-Sec yield that is accompanied by a widening credit spread may leave corporate bond yields unchanged, reducing the benefit for a corporate bond investor that was expected from the rate-cut cycle.

Example

Key benefits

How it works

1. 1
   Collect Yield Data Across Maturities

   Obtain current yields for Indian G-Secs across all available maturities - from 91-day T-Bills to 40-year dated bonds - from FBIL, the RBI website, CCIL, or NSE's bond market data.

2. 2
   Plot Maturity on X-Axis, Yield on Y-Axis

   Place maturity (time to redemption) on the horizontal axis and the corresponding yield to maturity on the vertical axis, producing a scatter of data points that represent the raw term structure.

3. 3
   Fit a Smooth Curve

   Apply a mathematical fitting model such as Nelson-Siegel-Svensson to the data points to produce a smooth, continuous yield curve that removes the noise of individual bond-specific factors like coupon rates and liquidity differences.

4. 4
   Identify the Curve's Shape and Key Segments

   Visually and quantitatively assess whether the curve is normal, steep, flat, inverted, or humped, and identify which segments - short, medium, or long end - are driving the dominant shape.

5. 5
   Calculate Key Spreads and Forward Rates

   Compute the 10-2 spread, the 10-year versus T-Bill spread, and key forward rates to quantify the degree of steepness or flatness and to extract the market's implied expectations for future rate movements.

6. 6
   Contextualise Against RBI Policy and Macro Data

   Overlay RBI's current repo rate, recent MPC statements, inflation data (CPI), GDP growth trends, and the government's fiscal deficit and borrowing programme to understand why the curve has its current shape.

7. 7
   Apply to Portfolio Decision-Making

   Use the insights derived from steps 4 through 6 to make duration decisions (extend or shorten), assess roll-down opportunity in specific maturity buckets, and calibrate fixed-income allocations relative to investment horizon and risk tolerance.

Formula

Implied Forward Rate: (1 + Y_n)^n = (1 + Y_m)^m × (1 + F_{m,n-m})^(n-m)
where Y_n = n-year spot yield, Y_m = m-year spot yield, F_{m,n-m} = forward rate for (n-m) years starting m years from today.

Key takeaways

Frequently asked questions

Related terms