yield curve

Examples of yield curve in the following topics:

• Using the Yield Curve to Estimate Interest Rates in the Future

  • Yield curves on bonds and government provided securities are correlative, and are useful in projected future rates.
  • This is referred to as a yield curve.
  • Inverted yield curves are typically predictors of recession, while positively sloped yield curves indicate inflationary growth.
  • When it comes to interest rates specifically, yield curves are useful constructs in projecting future behavior.
  • This yield curve from 2005 demonstrates the projected yield over time of USD.

• The Yield Curve

  • In finance the yield curve is a curve showing several yields or interest rates across different contract lengths (two month, two year, 20 year, etc...) for a similar debt contract.
  • Based on the shape of the yield curve, we have normal yield curves, steep yield curves, flat or humped yield curves, and inverted yield curves .
  • The yield curve is normal meaning that yields rise as maturity lengthens (i.e., the slope of the yield curve is positive).
  • A flat yield curve is observed when all maturities have similar yields, whereas a humped curve results when short-term and long-term yields are equal and medium-term yields are higher than those of the short-term and long-term.
  • An inverted yield curve occurs when long-term yields fall below short-term yields.

• Term Structure of Interest Rates

  • Yield curve for years 2000 and 2006 predicted the recessions in 2001 and 2007.
  • Yield curve could display a positive, negative, or flat slope and has two characteristics.
  • Economists use the yield curve to predict economic activity.
  • Although many economists and analyst use the yield curve to forecast recessions, the yield curve is not a perfect predictor.
  • The Yield Curve for U.S. government securities for three specific dates

• Chapter Questions

  • Explain both the term structure of interest rates and the yield curve.
  • Which three theories explain the characteristics of the yield curve?
  • If you saw a yield curve with a negative slope, which economic phenomenon would you predict to occur in a year?

• The Term Structure

  • Term structure of interest rates is often referred to as the yield curve.
  • In finance, the yield curve is a curve showing several yields or interest rates across different contract lengths (2 month, 2 year, 20 year, etc...) for a similar debt contract.
  • Because of the term premium, long-term bond yields tend to be higher than short-term yields, and the yield curve slopes upward.
  • This theory explains the predominance of the normal yield curve shape.
  • The US dollar yield curve as of February 9, 2005.

• Default Risk and Bond Price

  • Then economists can plot the term structure, called the yield curve.
  • Yield curve usually slopes upward and means the long-term U.S. government securities pay a higher interest rate than the short-term ones.
  • Economists use three theories to explain the characteristics of the yield curve and utilize the yield curve to predict recessions.

• Answers to Chapter 9 Questions

  • Expectations theory is for investors to invest in longer-term securities; they expect the interest rate to be greater, causing a positively sloping yield curve.
  • Preferred habitat theory does the best in explaining the yield curve.
  • When a yield curve has a negative slope, the investors are pessimistic about the future, and the economy usually enters a recession a year later.

• Calculating Yield to Maturity Using the Bond Price

  • The yield to maturity is the discount rate that returns the bond's market price: YTM = [(Face value/Bond price)1/Time period]-1.
  • The yield to maturity is the discount rate which returns the market price of the bond.
  • Formula for yield to maturity: Yield to maturity(YTM) = [(Face value/Bond price)1/Time period]-1
  • As can be seen from the formula, the yield to maturity and bond price are inversely correlated.
  • Even though the yield-to-maturity for the remaining life of the bond is just 7%, and the yield-to-maturity bargained for when the bond was purchased was only 10%, the return earned over the first 10 years is 16.25%.

• Time Lags and Targets

  • Yield Curve: Some economists suggested the Fed use the yield curve as an intermediate target.
  • Although the Fed examines the yield curve, the yield curve's shape depends on investors' expectations of inflation and real interest rates.

• Price Risk

  • Since the payments are fixed, a decrease in the market price of the bond means an increase in its yield.
  • Several curves depicting the inverse relationship between bond price and yield (interest rates).