Yield curve is a graphical representation of the yields of different financial instruments with a range of maturities. It is derived by plotting the rate of return for every bond maturity available in the market. It is used by traders, investors and analysts to measure the risk and profitability of investments with differing maturities. This graph can help traders make decisions about which investments to make and to assess future interest rate movements.
A yield curve is typically generated by graphing the yield of various Treasury securities such as T-Bills, Treasury notes or Treasury bonds. It is also possible to generate yield curves for other securities such as corporate bonds, municipal bonds, foreign government bonds, and mortgage-backed securities. Therefore, a yield curve provides a visual snapshot of the relationship between interest rates and the different maturities of different types of financial instruments.
The shape of the yield curve is generally indicative of the economic and financial environment. When yields on long-term investments are higher than those of short-term investments, the curve is said to be in a “normal” or “upward trending” shape. Conversely, when yields on short-term investments are higher than those of long-term investments, the curve is said to be in an “inverted” or “downward trending” shape. Flatter curves may be indicative of very low interest rates, while steeper curves may be generated when the market expects higher interest rates in the future.
Analysts, investors, and traders all use yield curves to evaluate different investments, create trading strategies, understand the economic climate, and measure and adjust individual risk. This graph is a commonly used tool to understand and predict changes in interest rates, and therefore is an essential part of any investor’s market analysis.
