Fixed Income Investments - Yield Curves

The U.S Federal Reserve (the Fed) has four tools it uses to directly influence short-term and, indirectly, long-term rate as well. They are:

  1. Open Market Operations: The Fed buys Treasuries or adds funds to the system; this reduces short-term rates. The Fed also sells Treasuries or takes funds out of the system to increase short-term rates.
  2. The Discount Rate: This is the rate at which banks can borrow on a collateralized basis at the Fed's discount window. If the Fed raises rates, they makes it more costly for the banks to do business, which drains cash from the system. If the Fed eases this rate, banks will find it cheaper to borrow additional funds, which will add cash to the system.
  3. Bank Reserve Requirements: This is hardly used these days. If the Fed raises these requirements, money is kept out of the economy. If they lower the rate, additional money will hit the economy.
  4. Verbal persuasion to influence how bankers supply credit to businesses and consumers: This simple method requires no additional explanation.

What is a Yield Curve?
A yield curve represents the relationship between maturity and yields. As an example:

1 Month 1.00%
3 Month 1.25%
6 Month 1.50%
1 Year 1.75%
2 Year 2.00%
5 Year 2.35%
10 Year 2.68%
30 Year 3.00%

If you were to graph this data you would see the yield curve develop. This date is only good for one single point in time because rates are constantly moving. If you are searching for a point on the yield curve that does not have a maturity represented by an actual "on the run security", that point will only be an approximation.

Yield Curve Shapes
Yield Curves come in three shapes:

  1. Upward or Normal Yield Curve: This curve occurs when short-term rates are lower than long-term rates, as noted in the above example.



  1. Inverted Yield Curve: This curve is formed when short-term rates are higher than the longer part of the curve.



  1. Flat Yield Curve: This curve occurs when there is little or no change between short-term and long-term rates.

The Term Structure of Interest Rates


Related Articles
  1. Investing

    Trade Bond ETFs Using Yield Curves

    Different types of yield curves provide important insights for trading bond-based securities.
  2. Bonds & Fixed Income

    The Impact Of An Inverted Yield Curve

    Find out what happens when short-term interest rates exceed long-term rates.
  3. Investing Basics

    Understanding the Inverted Yield Curve

    An inverted yield curve occurs during the rare times when short-term interest rates are higher than long-term interest rates.
  4. Investing News

    U.S. Recession Without a Yield Curve Warning?

    The inverted yield curve has correctly predicted past recessions in the U.S. economy. However, that prediction model may fail in the current scenario.
  5. Investing Basics

    Interest Rates And Your Bond Investments

    By understanding the factors that influence interest rates, you can learn to anticipate their movement and profit from it.
  6. Bonds & Fixed Income

    Yield Curve

    Learn more about how this curve is used to predict changes in economic output and growth.
  7. Economics

    What Is Supply?

    Supply is the amount of goods a producer is willing to produce at a given price, and is one of the most basic concepts in economics.
  8. Economics

    What is a Bell Curve?

    The bell curve is the most common type of graphed data distribution.
  9. Professionals

    Common Interview Questions for Fixed Income Traders

    Discover a list of potential questions and answers commonly asked in job interviews for a candidate applying for a position as a fixed-income trader.
  10. Term

    What is an Indifference Curve?

    An indifference curve determines the combinations of two goods that will provide equal satisfaction.
RELATED TERMS
  1. Normal Yield Curve

    A yield curve in which short-term debt instruments have a lower ...
  2. Flat Yield Curve

    A yield curve in which there is little difference between short-term ...
  3. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments ...
  4. Yield Elbow

    The point on the yield curve indicating the year in which the ...
  5. Yield Curve Risk

    The risk of experiencing an adverse shift in market interest ...
  6. Term Structure Of Interest Rates

    The relationship between interest rates or bond yields and different ...
RELATED FAQS
  1. Why are the term structure of interest rates indicative of future interest rates?

    Learn why economists believe the term structure for interest rates reflects investor expectations for future interest rates ... Read Answer >>
  2. What does the yield curve actually predict?

    Find out what an inverted yield curve represents, how it has performed as a leading indicator and why it appears to hold ... Read Answer >>
  3. What are the different formations of yield curves?

    Find out more about the yield curve and yield curve formations, what yield curves measure and the three main types of yield ... Read Answer >>
  4. What is the difference between the Daily Treasury Long-Term Rates and the Daily Treasury ...

    Find out more about the daily Treasury long-term rates, daily Treasury yield curve rates and the difference between these ... Read Answer >>
  5. What is the correlation between term structure of interest rates and recessions?

    Discover the importance of the term structure of interest rates, also known as the yield curve, and its predictive power ... Read Answer >>
  6. How can I create a yield curve in Excel?

    Find out more about the yield curve, what the yield curve is and how to create the yield curve for U.S. Treasury bonds using ... Read Answer >>
Hot Definitions
  1. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  2. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  3. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  4. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  5. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  6. Sharing Economy

    An economic model in which individuals are able to borrow or rent assets owned by someone else.
Trading Center