Yield curves are often created using only benchmark bonds and standard maturities, giving them a typically smooth appearance. However, when yield curves include all outstanding bonds from a particular issuer, the resulting curve actually often appears much less smooth. Take a look at the yield curve on the screen more precisely a part of the US treasury yield curve, covering bonds with maturities from 2040 to 2042. Instead of showing the smooth shape we've seen before, it takes a kind of zigzag shape. But why is this? The key reason is that not all bonds are created equal, even when they have the same issuer and very similar maturity dates. Several factors including coupon rates, duration, risk, tax, treatment, and liquidity, all play a role in why bonds from the same issuer can trade at different yields. Let's explore each of these in more detail, starting with coupon rates and cashflow preference.

In this example, the bonds with lower coupon rates tend to have higher yields to maturity. This might be in part because investors prefer bonds that offer larger, more frequent cash flows. As is the case with high coupon bonds. High coupon bonds provide more regular income, making them more attractive, so they trade at a premium resulting in lower yields. Conversely, lower coupon bonds don't provide as much regular income, so they trade at a discount which raises their yields. In addition, lower coupon bonds also tend to have longer durations, which means they are more sensitive to changes in interest rates.

This greater price volatility makes them riskier, so investors demand higher yields to compensate for this risk. Higher coupon bonds, on the other hand, have shorter durations, meaning they are less affected by interest rate changes resulting in lower yields. Another important aspect that affects yields is the tax treatment of bonds. Coupon payments are typically taxed as ordinary income, which makes higher coupon bonds less attractive to investors in higher tax brackets as they'll owe more taxes on the larger interest payments. However, lower coupon bonds which may be bought at a discount can offer capital gains upon maturity, and in some jurisdictions, capital gains might be taxed at a lower rate Than coupon income. This could make lower coupon bonds more attractive in a tax efficient strategy, though investors might still require a higher yield to compensate for the lower regular payments and the higher price sensitivity.

Finally, liquidity plays a big role in bond pricing. Bonds that are current benchmark bonds or were issued in larger quantities are typically more liquid, meaning they can be traded more easily without significantly affecting their price.

Investors are willing to accept lower yields on more liquid bonds because of the convenience and reduced risk in trading them. On the other hand, less liquid bonds, such as those issued in smaller quantities or those that are off the run, require higher yields to compensate for the added difficulty in buying and selling them at favorable prices.