Economics and The Time Value of Money - Yield Curve

Yield Curves
A yield curve is simply a graph that plots bond yields against their length of time to maturity. The curve will show whether short-term interest rates are higher or lower than long-term rates.

  • Normal Yield Curve
    • Most of the time, the yield curve will be positively sloped, which means lower interest rates are correlated with shorter maturities.
    • As maturity lengthens, interest rates increase.
    • For instance, if two-year Treasury notes yield 3%, five-year Treasury notes yield 4% and 10-year Treasury bonds yield 5.5%, then the yield curve will be sloped positively. This would be a normal yield curve.
    • The following diagram is of a normal yield curve, exhibiting a positive slope:

Figure 9.1: Normal Yield Curve

  • Inverted (or Negative) Yield Curve
    • Occurs when there is weak demand for bonds with short maturities, which drives yields up. A strong demand for long-term bonds drives these yields down.
    • An inverted yield curve means short-term interest rates are higher than long-term rates. This is an unusual situation, but it does happen.
    • An inverted yield curve may be an indication of economic decline.
    • For instance, an inverted yield curve would result if the two-year Treasury note yielded 3%, the five-year Treasury note 2.75% and the 10-year Treasury bond 2.5%.
    • This would occur if rates were high but expected to fall.
    • Consider the following diagram for a visual interpretation of an inverted yield curve:

Figure 9.2: Inverted Yield Curve



  • Flat Yield Curve
    • Occurs where yields are the same for short, intermediate, and long-term bonds.
    • This type of curve is a rare occurrence.

The flat yield curve is essentially a "flat" line.
Time Value of Money: Present and Future Value


Related Articles
  1. 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.
  2. Investing

    Trade Bond ETFs Using Yield Curves

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

    The Impact Of An Inverted Yield Curve

    Find out what happens when short-term interest rates exceed long-term 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. Fundamental Analysis

    Understanding Term Structure of Interest Rates

    The term structure of interest rates is a common method of valuing bonds.
  6. Bonds & Fixed Income

    Yield Curve

    Learn more about how this curve is used to predict changes in economic output and growth.
  7. Bonds & Fixed Income

    How Bond Market Pricing Works

    Learn the basic rules that govern how bond prices are determined.
  8. Term

    Understanding Interest Rates Inflation And The Bond Market

    Interest rates, bond yields and inflation expectations are all correlated.
  9. Bonds & Fixed Income

    Understanding Interest Rates, Inflation And Bonds

    Get to know the relationships that determine a bond's price and its payout.
  10. 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.
RELATED TERMS
  1. Flat Yield Curve

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

    A line that plots the interest rates, at a set point in time, ...
  3. Inverted Yield Curve

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

    A yield curve in which short-term debt instruments have a lower ...
  5. Yield Elbow

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

    The risk of experiencing an adverse shift in market interest ...
RELATED FAQS
  1. 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 >>
  2. What is the difference between term structure and a yield curve?

    Understand the difference between the term structure of interest rates and a yield curve, if any. Learn what the yield curve ... Read Answer >>
  3. How can the yield curve help me make investment decisions?

    Learn about the yield curve, and discover why this chart is an important economic indicator. How do Treasury bond yields ... Read Answer >>
  4. 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 >>
  5. 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 >>
  6. What is the current yield curve and why is it important?

    Understand what the current yield curve represents, and learn how market analysts commonly interpret various changes in the ... Read Answer >>
Hot Definitions
  1. 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, ...
  2. 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.
  3. 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 ...
  4. 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 ...
  5. Sharing Economy

    An economic model in which individuals are able to borrow or rent assets owned by someone else.
  6. Unlevered Beta

    A type of metric that compares the risk of an unlevered company to the risk of the market. The unlevered beta is the beta ...
Trading Center