One Would Expect That If a Country Has a Government

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The Answer is First, there may be technical reasons why within a government bond market some of the interest rates may not be representative of the true interest rate but instead be biased by some technical or regulatory factor unique to that market. For example, market participants may need to cover a short position in a particular government bond and the actions to cover a short position would push up the demand for that particular government bond and drive down its yield. In the swap market, there is nothing that has to be delivered so technical market factors have less of an impact. Also, there may be government bonds selling above or below their par value. Moreover, as explained earlier, government tax authorities might tax such bonds differently if they are purchased and held to maturity. As a result, the yields at which these bonds trade in the marketplace will reflect any tax advantage or disadvantage. Although it may be difficult to appreciate these factors at this point in your study of financial markets, the key is that the observed interest rate on government securities may not reflect the true interest rate due to these factors. This is not the case for swap rates. There is no regulation of this market and hence swap rates represent true interest rates. However, remember that swap rates do reflect credit risk and liquidity risk.
Second, to create a representative government bond yield curve, a large number of maturities must be available. However, in most government bond markets, securities with only a few maturities are issued. While there are a good number of off-the-run issues available from which to construct a government bond yield curve, the yields on such issues may not be true interest rates for the reasons noted previously. In contrast, in the swap market, a wide range of maturities are quoted. In fact, in the United States, there was a suspension in the issuance of 30-year bonds, and as a result, 30-year Treasury rates were unavailable. Yet, swap dealers quoted 30-year swap rates. Finally, the ability to compare government yields across countries is difficult because there are differences in the credit risk for every country. In contrast, as explained earlier, the swap curve is an interbank yield curve and thereby makes cross-country comparisons of benchmark interest rates easier.

One Would Expect That If a Country Has a Government

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One Would Expect That If a Country Has a Government

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