Loading the player...

What is a 'Yield Curve'

A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality but differing maturity dates. The most frequently reported yield curve compares the three-month, two-year, five-year and 30-year U.S. Treasury debt. This yield curve is used as a benchmark for other debt in the market, such as mortgage rates or bank lending rates, and it is also used to predict changes in economic output and growth.Yield Curve

BREAKING DOWN 'Yield Curve'

The shape of the yield curve gives an idea of future interest rate changes and economic activity. There are three main types of yield curve shapes: normal, inverted and flat (or humped). A normal yield curve is one in which longer maturity bonds have a higher yield compared to shorter-term bonds due to the risks associated with time. An inverted yield curve is one in which the shorter-term yields are higher than the longer-term yields, which can be a sign of upcoming recession. In a flat or humped yield curve, the shorter- and longer-term yields are very close to each other, which is also a predictor of an economic transition.

Normal Yield Curve

A normal or up-sloped yield curve indicates yields on longer-term bonds may continue to rise, responding to periods of economic expansion. When investors expect longer-maturity bond yields to become even higher in the future, many would temporarily park their funds in shorter-term securities in hopes of purchasing longer-term bonds later for higher yields. In a rising interest rate environment, it is risky to have investments tied up in longer-term bonds when their value has yet to decline as a result of higher yields over time. The increasing temporary demand for shorter-term securities pushes their yields even lower, setting in motion a steeper up-sloped normal yield curve.

Inverted Yield Curve

An inverted or down-sloped yield curve suggests yields on longer-term bonds may continue to fall, corresponding to periods of economic recession. When investors expect longer-maturity bond yields to become even lower in the future, many would purchase longer-maturity bonds to lock in yields before they decrease further. The increasing onset of demand for longer-maturity bonds and the lack of demand for shorter-term securities lead to higher prices but lower yields on longer-maturity bonds, and lower prices but higher yields on shorter-term securities, further inverting a down-sloped yield curve.

Flat Yield Curve

A flat yield curve may arise from normal or inverted yield curve, depending on changing economic conditions. When the economy is transitioning from expansion to slower development and even recession, yields on longer-maturity bonds tend to fall and yields on shorter-term securities likely rise, inverting a normal yield curve into a flat yield curve. When the economy is transitioning from recession to recovery and potentially expansion, yields on longer-maturity bonds are set to rise and yields on shorter-maturity securities are sure to fall, tilting an inverted yield curve toward a flat yield curve.

RELATED TERMS
  1. Yield Curve Risk

    The yield curve risk is the risk of experiencing an adverse shift ...
  2. Yield Elbow

    The point on the yield curve indicating the year in which the ...
  3. Normal Yield Curve

    A yield curve in which short-term debt instruments have a lower ...
  4. Curve Steepener Trade

    Curve steepener trade is a strategy that uses derivatives to ...
  5. Riding the Yield Curve

    A trading strategy that is based upon the yield curve and used ...
  6. Humped Yield Curve

    A relatively rare type of yield curve that results when the interest ...
Related Articles
  1. Investing

    The Impact of an Inverted Yield Curve

    Understand how the relationship between short- and long-term interest rates contributes to an inverted yield curve, a noteworthy economic event.
  2. Investing

    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.
  3. Insights

    Is a Recession in the Works? Ask an Inverted Yield Curve

    An inverted yield curve has predicted the last seven recessions. Is number eight around the corner?
  4. Investing

    A Flattening Yield Curve Is Good For The Economy and Stocks

    Wall Street is concerned because the yield curve is flattening, but that doesn't mean a recession is near.
  5. Insights

    Is a Recession Coming? Watch the Yield Curve

    The yield curve can be an indicator of which way the economy is heading.
  6. Investing

    Bond Yield Curve Holds Predictive Powers

    This measure can shed light on future economic activity, inflation levels and interest rates.
  7. Investing

    How Bond Market Pricing Works

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

    Understanding the Different Types of Bond Yields

    Any investor, private or institutional, should be aware of the diverse types and calculations of bond yields before an actual investment.
  9. Investing

    How Rising Interest Rates and Inflation Affect Bonds

    Understand bonds better with these four basic factors.
  10. Investing

    Calculating Yield to Worst

    Yield to worst is the lowest possible yield on a bond that may be called in the future.
RELATED FAQS
  1. 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 >>
  2. 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 >>
  3. 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 >>
  4. What does market segmentation theory assume about interest rates?

    Learn about how the market segmentation theory for different maturities of interest rates seeks to describe the shape of ... 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. Gross Domestic Product - GDP

    GDP is the monetary value of all the finished goods and services produced within a country's borders in a specific time period, ...
  2. Debt/Equity Ratio

    The D/E ratio indicates how much debt a company is using to finance its assets relative to the value of shareholders’ equity.
  3. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange.
  4. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  5. Return On Equity - ROE

    The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability ...
  6. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
Trading Center