The Yield Curve

Yield Curve

A yield curve is a line graph that plots the relationship between the yield of a bond and its maturities.

They are created by plotting the yields of different maturities for the same type of bond. The “spreads” between the yields of different maturities are what create the slope, or shape, of the yield curve for a given type of security.

Yield curves can be created for any kind of fixed income security. The yield curve for US Treasury securities is considered a market benchmark to evaluate market conditions.

Normal Yield curve

 

Properties of Normal Yield Curve

  1. A normal yield curve is upward sloping.
  2. longest maturity bonds will have higher yields as compared to short maturity bonds.
  3. This is normal because longer-term securities bear higher risks and hence the returns are higher and short term securities bear lower risks and hence the returns are lower.

Inverted Yield Curve

 

Properties of an Inverted Yield Curve

  1. An inverted yield curve is downward sloping.
  2. Yield from long term bonds fall below short term bonds.
  3. This is inverted because, even though the returns from longer-term securities bear higher risks, the returns are lower and while short term securities bear lower risks the returns are higher.

Flat Yield Curve

 

Properties of a flat Yield Curve

  1. A flat yield curve is one when all the maturities are close to each other.
  2. Yield from long term bonds fall below short term bonds.

As yield increases, the bond price decreases.

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