Yield curve is a chart consisting of the yields of bonds of the same quality but
different maturities. This is used as a measure to assess the future of interest
rates. Here, the time value is plotted on the X-axis and yields on the Y-axis. The
curve graphically demonstrates the rate at which market participants are willing
to transact debt capital for the short term, medium term and long term. The yield
curve is positive when long-term rates are higher than short-term rates; however,
the yield curve is sometimes negative or inverted.
Types of yield curve
Normal Yield Curve
When long-term interest rates are higher compared to short-term interest rates,
the shape of the yield curve is upward sloping.
Steep Yield Curve
This curve is normally observed at the beginning of an economic expansion or just
at the end of a recession. The slope of the yield curve increases as the difference
between long-term yields and short-term yields become wider. The inherent assumption
behind such a curve could be that while short-term economic conditions warrant lower
rates, factors like inflation, etc. could rise in the medium / long-term justifying
much higher long-term rates.
Flat Yield Curve
When there is no change in market outlook on interest rates, we get flat yield curve.
This is because yields are almost same across tenors.
Inverted Yield Curve
When short-term interest rates are higher than long-term interest rates the shape
of yield curve takes downward sloping. This happens when markets expect high volatility
in the near future however long term story remains same.
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