A yield curve portrays rates of interest of bonds having different maturities, however same credit quality, at a specific moment. The yield curve is mostly used to compare rates of various maturity government securities that vary from three months to thirty years. This curve also acts as a yardstick for other set interest instruments consisting of mortgages and bank loans. Moreover, financiers can use this curve to approximate basic financial conditions. This details can be used by the financiers to make appropriate financial investment decisions.
Explanation of the Yield Curve
A yield curve is studied to gain an insight about the financial activities in a nation during a specific duration of time. The curve plots the yields and the time to maturity of the financial obligations. Shape of the curve reveals important characteristics of the fixed income instruments. Analyzing the yield curve helps individuals in estimating future rates and financial activities in a country.
Types of Yield Curve
There are various types of yield curves that show modification in rates of different set income instruments. Yield curves that portray change in rates of government securities are called federal government bond yield curve. Then there is the LIBOR yield curve that is the rate at which banks obtain from each other and which is relatively greater as compared to federal government bond yield curves. The business yield curve shows modification in rates of business bonds.
Apart from different kinds of yield curves, there are various shapes of the curves. The 3 primary types of curves consist of typical, inverted and humped (or flat) shaped curves.
Normally, the yields curve is favorably sloped that represents an increase in the bond yields as it comes nearer to maturity. In this scenario the yield of short-term debt are lower as compared to the same quality long-term debt instruments.
However, in some cases the yield curve is inverted that represents decline in the bonds. This held true during the 19th and early 20th century in the US when the economy skilled development with deflationary trends. During this duration the yield on long term debts is the small term debts have higher yields as compared to same quality long term financial obligations.
The 3rd type of curve that is humped or flat-shaped curve is unusual and takes place when the rate on the medium term bonds are greater as compared to both brief and long term repaired income instruments. This kind of curve is often likewise known as bell shaped yield curve.
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