A bond represents a debt relationship between the bond holder and the issuer. Bond yield is often
affected by the changes in interest rates. The central bank (Bank of Ghana) reviews the interest
rate from time to time based on inflation rate and other macroeconomic variables like money
supply and market liquidity. Bonds can be affected by changes in short-term versus long-term
interest rates in various ways. Bond yield curve can be constructed by plotting the prices of
different maturity bonds. The yield curve shows the relationship between yield and maturity.
Yield curve work best when plotting different maturity dates for the same type of bond and by
comparing the bond yield that are similar, but with differing maturities, one can generate a graph
which shows how yields change as the maturity date lengthens (Suresha & Shruthi, 2015).
Empirical researches have shown that yield curve depicts a shift in line when there is a shock,
which are often called “level,” “slope” and “curvature” (Litterman and Scheinkman, 1991 as
cited in Suresha & Shruthi, 2015). Yield curve shows a line that rises from lower interest rates on
shorter-term bonds to higher interest rates on longer-term bonds. Researchers have found that
shifts or changes in the shape of the yield curve are attributable to a few unobservable factors
(Dai and Singleton, 2000 as cited in Suresha & Shruthi, 2015). The “level,” “slope” and
“curvature names describe how the yield curve shifts or changes shape in response to a shock.
Shock is an event like change in the interest rate or change in the inflation rate of a country.
According to Suresha & Shruthi (2015), a “level” shock changes the interest rates of all
maturities by almost identical amounts, inducing a parallel shift that changes the level of the
whole yield curve. The shock to the “slope” factor increases short-term interest rates by much
larger amounts than the long-term interest rates, so that the yield curve becomes less steep and its
slope decreases. In Tao Wu’s study (as cited in Suresha & Shruthi, 2015), the main effects of the
shock focus on medium-term interest rates, and consequently the yield curve becomes more
“hump-shaped” than before. Scholarly works have produced models to estimate the characteristic
movement of the macro economic factors. However, to Suresha & Shruthi (2015),few of these
models provide any intuition about what these factors are, about the identification of the
underlying forces that drive their movements or about their responses to macroeconomic
variables. Yet these issues are of most interest to central bankers and macroeconomists.