What is the 'Yield Curve Risk'
The yield curve risk is the risk of experiencing an adverse shift in market interest rates associated with investing in a fixed income instrument. When market yields change, this will impact the price of a fixedincome instrument. When market interest rates, or yields, increase, the price of a bond will decrease, and vice versa.
BREAKING DOWN 'Yield Curve Risk'
Investors pay close attention to the yield curve as it provides an indication of where short term interest rates and economic growth are headed in the future. The yield curve is a graphical illustration of the relationship between interest rates and bond yields of various maturities, ranging from 3month Treasury bills to 30year Treasury bonds. The graph is plotted with the yaxis depicting interest rates, and the xaxis showing the increasing time durations. Since shortterm bonds typically have lower yields than longer term bonds, the curve slopes upwards from the bottom left to the right. This is a normal or positive yield curve. Interest rates and bond prices have an inverse relationship in which prices decrease when interest rates increase, and vice versa. Therefore, when interest rates change, the yield curve will shift, representing a risk, known as the yield curve risk, to a bond investor.
The yield curve risk is associated with either a flattening or steepening of the yield curve, which is a result of changing yields among comparable bonds with different maturities. When the yield curve shifts, the price of the bond, which was initially priced based on the initial yield curve, will change in price.
Flattening Yield Curve
When interest rates converge, the yield curve flattens. A flattening yield curve is defined as the narrowing of the yield spread between long and shortterm interest rates. When this happens, the price of the bond will change accordingly. If the bond is a shortterm bond maturing in three years and the threeyear yield decreases, the price of this bond will increase.
Let’s look at an example of a flattener. Let’s say the Treasury yields on a 2year note and a 30year bond are 1.1% and 3.6%, respectively. If the yield on the note falls to 0.9%, and the yield on the bond decreases to 3.2%, the yield on the longerterm asset has a much bigger drop than the yield on the shorterterm Treasury. This would narrow the yield spread from 250 basis points to 230 basis points.
A flattening yield curve can indicate economy weakness as it signals that inflation and interest rates are expected to stay low for a while. Markets expect little economic growth and the willingness of banks to lend is weak.
Steepening Yield Curve
If the yield curve steepens, this means that the spread between long and shortterm interest rates widens. In other words, the yields on longterm bonds are rising faster than yields on shortterm bonds, or shortterm bond yields are falling as longterm bond yields are rising. Therefore, longterm bond prices will decrease relative to shortterm bonds.
A steepening curve typically indicates stronger economic activity and rising inflation expectations, and thus, higher interest rates. When the yield curve is steep, banks are able to borrow money at lower interest rates and lend at higher interest rates. An example of a steepening yield curve can be seen in a 2year note with a 1.5% yield and a 20year bond with a 3.5% bond. If after a month, both Treasury yields increase to 1.55% and 3.65%, respectively, the spread increases to 210 basis points, from 200 basis points.
Inverted Yield Curve
On rare occasions, the yield on shortterm bonds is higher than the yield on longterm bonds. When this happens, the curve becomes inverted. An inverted yield curve indicates that investors will tolerate low rates now if they believe rates are going to fall even lower later on. So, investors expect lower inflation rates, and interest rates, in the future.
Trading the Yield Curve Risk
Any investor holding interestrate bearing securities is exposed to yield curve risk. To hedge against this risk, investors can build portfolios with the expectation that if interest rates change, their portfolios will react in a certain way. Since changes in the yield curve are based on bond risk premiums and expectations of future interest rates, an investor that is able to predict shifts in the yield curve will be able to benefit from corresponding changes in bond prices.
In addition, shortterm investors can take advantage in yield curve shifts by purchasing either of two exchangetraded products  the iPath US Treasury Flattener ETN (FLAT) and the iPath US Treasury Steepener ETN (STPP).

Curve Steepener Trade
Curve steepener trade is a strategy that uses derivatives to ... 
Flat Yield Curve
The flat yield curve is a yield curve in which there is little ... 
Term Structure Of Interest Rates
The term structure of interest rates is the relationship between ... 
Bull Flattener
A bull flattener is a yieldrate environment in which longterm ... 
Yield Curve
A yield curve is a line that plots the interest rates, at a set ... 
Bull Steepener
A bull steepener is a change in the yield curve caused by shortterm ...

Investing
Bond yield curve holds predictive powers
This measure can shed light on future economic activity, inflation levels and interest rates. 
Investing
The impact of an inverted yield curve
Understand how the relationship between short and longterm interest rates contributes to an inverted yield curve – a noteworthy economic event. 
Investing
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. 
Insights
Understanding The Treasury Yield Curve Rates
Treasury yield curves are a leading indicator for the future state of the economy and interest rates. 
Investing
One Thing The Yield Curve Says About Stocks
Contrary to media hype, a flattening yield curve does not mean a recession is coming soon. 
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? 
Investing
Charles Schwab: LargeCap Stocks Could Restart Their Outperformance
Owing to a flattening of the yield curve, Charles Schwab said that largecap stocks could outperform again. 
Investing
3 Risks U.S. Bonds Face in 2016
Learn about the major risks for the bond market in 2016; interest rate increases, highyield bond volatility and a flatter yield curve may be issues. 
Investing
The Bond Investor's Challenge: Generating Yield in a Low Interest Environment
Discover expert advice on how to generate higher yield in a bond portfolio in 2016, despite the global challenges of low rates and high debts.

How can I create a yield curve in Excel?
Yield curves indicate where future interest rates are headed and you can actually make one in excel. Find out more about ... Read Answer >> 
What causes a bond's price to rise?
Should you invest into bonds? Learn about factors that influence the price of a bond, such as interest rates, credit ratings, ... Read Answer >> 
Is there a difference between financial ratio analysis and accounting ratio analysis?
Discover the economic factors that most influence corporate bond yields. Corporate bond yields reflect the market's assessment ... Read Answer >> 
What is the difference between yield to maturity and the yield to call?
Determining various the various yields that callable bonds can provide investors is an important factor in the bond purchasing ... Read Answer >> 
Current yield vs yield to maturity
Learn about the relationship between a bond's current yield and its yield to maturity, including how the market price of ... Read Answer >>