Interest Rate Risk - The Impact of the Yield Curve on Treasury Bill Returns

Interest rate risk involves the risk to earnings or capital arising from movement of interest rates. It arises from differences between the timing of rate changes and the timing of cash flows (re-pricing risk); changing rate relationships among yield curves that affect bank activities (basic risk); from changing rate relationships across the spectrum of maturities (yield curve risk); and from interest-rate-related options entrenched in bank products (option risk). This paper assessed the impact of the level, slope and curvature components of the yield curve on treasury bill returns using secondary data to draw quarterly yield curves for the various maturity periods. This approach was extended to capture the sensitivity to changes in the level, slope, and curvature of the term structure using the parameters of the dynamic [14] model to fit the term structure. The results revealed that, the shorter the yield to maturity the stable and better the returns or yield. Applying dynamic factor models, it was seen that, the slope factor representing the short term component had better returns compared to the medium term and the long term components. Also, the results revealed that, the 91 day T-bill which represents the short term component produced better and much stable returns compared with the 182 day T- bill and 1 year note representing the medium and long term components respectively.