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 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, while 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.

    • 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.

    • The following diagram represents 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.

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:

If a bond is bought at a discount, the yield to maturity would be:

  1. The same as the nominal yield
  2. Lower than the nominal yield
  3. Higher than the nominal yield
  4. Not enough information to determine the answer

The correct answer is "c" - since the buyer paid less than par, the yield to maturity will be higher than the nominal yield.

Corporate Bonds
Related Articles
  1. Professionals

    Career Advice: Financial Analyst Vs. Investment Banker

    Read an in-depth comparison about working as a Financial Analyst vs. working as an Investment Banker, two highly prestigious business careers.
  2. Professionals

    Who Needs to Take the Series 65?

    Most states require individuals to pass the Series 65 exam in order to act as investment advisors.
  3. Personal Finance

    RIAs and Brokers: What's the Difference?

    RIAs and brokers are held to different standards when providing investment advice. Here's how they differ.
  4. Investing Basics

    Brokers and RIAs: One and the Same?

    Brokers and registered investment advisors have some key differences. Here's what you need to know.
  5. Professionals

    Understanding Series 6

    Upon successful completion of the Series 6, an individual will have the qualifications needed to sell open end mutual funds and variable annuities
  6. Professionals

    Top Strategies on How to Become a Stock Broker

    Gunning to be a stock broker and want an edge? Here's some veteran advice.
  7. Trading Systems & Software

    Steps to Starting Up an Independent Broker Dealer

    Launching your own broker-dealer is a lot of work, but the potential payoff is great, both personally and financially.
  8. Professionals

    Understanding Series 63

    Series 63 is a securities license that entitles the holder to sell securities in a particular state.
  9. Professionals

    How To Answer Option Questions On The Series 7 Exam

    Learn how to answer option questions on the Series 7 exam. Pass your Series 7 exam with the help of these tips.
  10. Insurance

    Municipal Bond Tips For The Series 7 Exam

    Learn to distinguish between general obligation and revenue bonds to ace this test.
  1. Series 6

    A securities license entitling the holder to register as a limited ...
  2. Series 79

    A examination to ensure a candidate is qualified to become a ...
  3. Research Analyst

    A person who prepares investigative reports on equity securities. ...
  4. Series 34

    An exam required for individuals seeking to engage in off-exchange ...
  5. Financial Advisor

    One who provides financial advice or guidance to customers for ...
  6. Series 23

    An exam offered by the Financial Industry Regulatory Authority ...
  1. Is a financial advisor required to have a degree?

    Financial advisors are not required to have university degrees. However, they are required to pass certain exams administered ... Read Full Answer >>
  2. Do financial advisors have to be licensed?

    Financial advisors must possess various securities licenses in order to sell investment products. The specific products an ... Read Full Answer >>
  3. If I have only a limited amount of time to study for the Series 6, what should I ...

    The Series 6 Investment Company and Variable Contracts Products Representative Qualification Examination is administered ... Read Full Answer >>
  4. What role does the 'chip cycle' play in the electronics sector?

    There are several highly acclaimed private Series 6 Exam courses in the United States. Many can be completed online. Popular ... Read Full Answer >>
  5. What does passing the Series 6 enable me to do?

    The Series 6, or the Investment Company Products/Variable Contracts Limited Representative, exam is administered by the Financial ... Read Full Answer >>
  6. What are the differences between the Series 6 exam and the Series 7 exam?

    The Financial Industry Regulatory Authority (FINRA) offers a variety of licenses that must be obtained before conducting ... Read Full Answer >>
Hot Definitions
  1. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  2. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  3. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  4. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  5. Cost Of Funds

    The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one ...
  6. Cost Accounting

    A type of accounting process that aims to capture a company's costs of production by assessing the input costs of each step ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!