Normal Yield Curve
What it is:
Also called a positive, a normal yield curve is one in which short-term yields are lower than long-term yields.
How it works/Example:
A bonds against their maturities, ranging from shortest to longest. Note that the chart does not plot coupon rates against a range of maturities -- that's called a spot curve.
The shows whether short-term yields are higher or lower than long-term yields. There are three main types of . The most common is the positive . If short-term yields are higher than long-term yields, the curve is called an inverted (or "negative") . A exists when there is little or no difference between short- and long-term yields. See the picture below for an example of a normal .
It is important that only bonds of similar risk are plotted on the same benchmark for determining the on other types of debt.
The shape of the changes over time, and curves are calculated and published by The Journal, the Federal Reserve and many financial institutions.
Why it matters:
Generally, a normal yield curve indicates that investors require a higher rate of return for taking the added risk of lending money for a longer period of time. Many economists also believe that a steep positive curve indicates investors expect higher future inflation (and thus higher interest rates), and that a sharply means investors expect lower inflation (and interest rates) in the future. A flat curve generally indicates investors are unsure about future economic growth.
Because the is generally indicative of future interest rates, which are indicative of an 's expansion or contraction, curves and changes in curves can convey much information. Changes in the shape of the also affect a portfolio's return in that they make some more or less valuable relative to other . These concepts are part of what motivates analysts to study curves carefully.