Yield Curve

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.