What is a Yield Curve?

Many investors in the stock market have comewill invest in will be entirely another factor to
to hear of the term 'yield curve'. This termconsider.
actually is used to denote the relationship betweenPlotted Yield Curve of Treasury Securities
the cost of borrowing or the interest rate andFinancial markets around the world usually relies in
the time or term of maturity of a certain debtthe US Federal Reserve for their regular
instrument in a particular currency.publication containing plotted yield curve based on
Traders in the different markets closely watchesupdated rates and terms of Treasury Securities.
the US dollar interest rates paid on US TreasuryGlobal markets use these plotted yields as basis
securities in varying maturities by plotting them onfor measuring yield on other kinds of debt
a graph known as the yield curve. Anyinstruments.
movements in rates and maturities of USImportance of Yield Curve to the Economy
Treasury securities as plotted by the yield curveBy using the yield curve, investors, traders and
will impact on stock markets worldwide.economist alike can ascertain the financial standing
Yield Curve and US Ratesor situation of the economy. When the upward
The yield curve in terms of US governmentcurve is on a sloping line, it would mean that a
instruments like bonds and treasury notes is ahigher rate is need by investors due to longer
way of evaluating short and long term investmentmaturities. A steep upward slope means economy
trends and would necessarily reflect the country'sis bullish with a corresponding need for higher
economic outlook.rates. A flat curve is indicative of uncertainty in
This is why all traders in the different financialthe direction of the economy.
markets of the world closely monitors the varyingThe Economy on an Inverted Yield Curve
interest rates and maturities on US governmentThe inverted yield curve was plotted just recently
securities to determine the yield curve that wouldnot elsewhere but in mainland USA. The financial
also serve as their basis in determining their owncredit crunch brought about by the Home
rates for short, medium and long term debtMortgage problem and exacerbated further by
instruments.the skyrocketing cost of fuel brought about this
Three Forms of Yield Curveinverted curve that suggested to everyone to
In actuality, there are three kinds of forms that aexpect a slowing down of economic growth and
yield curve can take depending on the interplay oflow inflation
interest offered and the length of maturity.The lowering of rates was forced on the
An upward curve is normal and would indicate aGovernment to preclude recession from hitting
higher yield for longer maturity while a downwardthe economy. The adjustment in the lowering of
curve is not normal and would mean higher yieldthe interest rates by the Federal Reserve was
for shorter maturing instruments. Downwardmade in response to the bleak economic forecast.
curves or inverted curves are abnormal andIt was done in several stages so as not to jolt
would signify an economy nearing recession. A flatthe economy until it reached 50 points
yield would signify there is no difference inYield Curve Theories
interest between short and long termThere were several theories regarding the Yield
investments.Curve that sought to explain the nature of the
Yield Curve in Bondscurvature. These theories all related the yield
For investors in bonds it will serve them well ifcurve to the desires of the investors in relation to
they examine carefully the kind of bonds they willinterest rates and the maturity of their
be investing because notwithstanding the plottedinvestments.
yield, the risk attendant to the kind of bonds they