Business, Legal & Accounting Glossary
The yield curve shows the relationship between a bonds yield and maturity date.
The Yield Curve is a curve on a graph on which the yield on deposits or fixed-interest securities are plotted against the length of time they have to run until Maturity. The yield curve typically slopes upwards, indicating that investors anticipate receiving a premium for holding onto securities that have a long time to run.
A negative yield curve (down-sloping curve) may occur however, when the market expects falling interest rates or deflation.
A flat (or humped) yield curve usually expressive of uncertainty in the market.
A yield curve is a plot of the yields of all bonds of the same quality, from lowest to highest maturity. The typical yield curve is based on the yield-maturity relationship of default-free US Treasury securities. There are three basic configurations for a yield curve, depending on interest rate levels and the general economic conditions. A positive yield curve shows short-term interest rates are lower than long-term interest rates. A flat yield curve results when short-term and long-term interest rates are about the same. A negative yield curve is seen when short-term interest rates are higher than long-term interest rates. The yield curve (especially the negative yield curve) can be a helpful tool in forecasting the future health of the economy.
In finance, it is a graph of the effective or real interest (the yield) of a security, usually a bond, against the length of time until all capital and interest has been paid back (the maturity). Yield curves are also called term structure of interest rates.
Yield curves offer meaningful insight if maturity is the only variable differing among the securities examined. Other properties, such as a bond’s credit rating or its call features, must be identical.
Fixed-income analysts, those who analyse bonds and related securities, use the yield curve to understand market conditions. Economists use it to understand economic conditions.
Yield curves are usually upward sloping and accelerating; the longer the maturity, the higher the yield. The usual explanation is that longer maturities entail greater risks for the investor, and so require higher yields. With longer maturities, more catastrophic events might occur that may impact the investment, hence the need for a risk premium. This explanation depends on the distant future being more uncertain than the near future, and risk of future adverse events (such as default and higher short-term interest rates) being higher than the chance of future positive events (such as lower short-term interest rates).
The reverse, when short term rates are higher than long term rates, results in an inverted yield curve. Inverted yield curves have historically preceded economic depressions.
Yield curves carry an implicit forecast of future short-term interest rates: for example if the annual yield on a 10-year bond is 5%, and on an 11-year bond is 5.5%, then the implicit yield in year 11 is
1.05511/1.0510 – 1 = 10.6%
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This glossary post was last updated: 26th April, 2020 | 2 Views.