
Cash Equivalents and Fixed Income Securities  Yield Curves
Ayield curve is simply a graph that plots bond yields against their time period to maturity. The curve will show whether shortterm interest rates are higher or lower than longterm 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 twoyear Treasury notes yield 3%, fiveyear Treasury notes yield 4% and 10year 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.
 Most of the time, the yield curve will be positively sloped, which means lower interest rates are correlated with shorter maturities.
Figure 9.1: 
 Inverted (or Negative) Yield Curve
 Occurs when there is weak demand for bonds with short maturities, which drives yields up, while a strong demand for longterm bonds drives these yields down
 An inverted yield curve means shortterm interest rates are higher than longterm rates. This is an unusual situation, but it does happen.
 An inverted yield curve may be an indication of economic decline.
 An inverted yield curve would result if the twoyear Treasury note yielded 3%, the fiveyear Treasury note 2.75% and the 10year Treasury bond 2.5%.
 This would occur if rates were high but expected to fall.
 The following diagram represents an inverted yield curve.
 Occurs when there is weak demand for bonds with short maturities, which drives yields up, while a strong demand for longterm bonds drives these yields down
Figure 9.2: Inverted Yield Curve 
 Flat Yield Curve
 Occurs where yields are the same for short, intermediate, and longterm bonds.
 This type of curve is a rare occurrence.
 The flat yield curve is essentially a flat line.
Figure 9.3: Flat Yield Curve 
Look Out! Generally, questions about yield curves relate either to demand or to where interest rates are heading based on the current curve. Read these questions carefully, since one of the incorrect choices may refer to where interest rates are at the time of the yield curve. 
Yield Spreads
This refers to the difference in interest rates between different classes of bonds. For example, corporate bonds always have a higher yield than government bonds due to their higher risk. However, the spread is not constant  it can fluctuate over time, based on factors such as:
 Investor expectations about the economy
 Issuer activity when a larger or smaller than usual amount of Treasuries is issued, it affects supply, which can affect yields and spreads
 Institutional investors (such as mutual funds or pension funds) heavily buying or selling a particular type of bond, which can also affect supply. and thus spreads
Exam Tips and Tricks You might encounter a question like this on the exam: 
 The same as the nominal yield
 Lower than the nominal yield
 Higher than the nominal yield
 Not enough information to determine the answer
Corporate BondsThe correct answer is "c"  since the buyer paid less than par, the yield to maturity will be higher than the nominal yield.
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RELATED TERMS

Flat Yield Curve
A yield curve in which there is little difference between shortterm ... 
Yield Curve
A line that plots the interest rates, at a set point in time, ... 
Inverted Yield Curve
An interest rate environment in which longterm debt instruments ... 
Normal Yield Curve
A yield curve in which shortterm debt instruments have a lower ... 
Yield Elbow
The point on the yield curve indicating the year in which the ... 
Yield Curve Risk
The risk of experiencing an adverse shift in market interest ...
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