An Analysis of Yield Curve Notes



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    • Department of Finance, Stokely Center for Management Studies, University of Tennessee. I wish to thank an Associate Editor for helpful comments and suggestions on an earlier draft. All remaining errors are, of course, my responsibility. This research has been supported in part by a research grant from the University of Tennessee.


This paper analyzes a new type of security, the yield curve note, which pays interest at a rate that varies inversely with short-term interest rates. A valuation model for yield curve notes is presented, the parameters of the model are estimated empirically, and the estimated model is used to explore, in simulation, the price behavior and risk characteristics of yield curve notes in comparison with fixed-rate notes. The risk of a yield curve note is approximately twice as great as a fixed-rate note with the same maturity. The unique risk characteristics of yield curve notes make them useful (as liabilities) in immunization strategies for financial institutions. Their usefulness in this regard may be the chief rationale for their development.