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The Yield Curve of Bonds
The yield curve shows the relation between the bond yields and the term to maturity of bonds at the same risk level. A test of the yield curve on any particular date gives you an instantaneous idea of the different yields of the various maturities for a bond security.
You can create a yield curve for several bond types such as Treasury, municipal, corporate and agency bonds.
An inverted curve is generally atypical, it indicates that by extending maturities investors are taking greater risks for smaller returns. Yield curves typically assume four general shapes: rising, flat, falling and humped. The most common type is the rising yield curve.
You might expect an upward-sloping curve because of the longer the maturity, the greater is the bondholder’s exposure to risk. For this reason, bond issuers tend to pay more to compensate investors for the risk involved with longer maturities, with interest rates 45-year low, this steeply positive yield curve points to higher future rates.
On few occasions, the yield curve has had a downward slope where short-term yields have exceeded long-term yields. In other words, yields decline as maturities increase. This situation happened in 1979, 1981, and 1982.
The shape of the yield curve changes daily with the changes in yield because of fluctuations in market rates of interest. The yield curve can assist you in choosing which maturities of bonds to buy.
Keep in mind the following generalities about yield curves:
- Most of the time the yield curve is upward-sloping, where yields on long-term securities are greater than the yields of short-term securities.
- Changes in the yield curve generally take the form of shifts up and down over time. When short-term yields are rising, generally long-term yields also rise. Similarly, when short-term yields are falling long-term yields also fall.
- During a recession period, short-term yields fall faster than long-term yields; during a period of economic growth short-term yields rise faster than long-term yields.
Using the Internet get yields for the different Treasury securities to construct a yield curve. Based on the shape of the yield curve decide whether you would invest in long or short-term maturity bonds.
Yields for the three-month, six-month, two-year, 5-year, 10-year and thirty-year treasury securities are plotted.
US Treasury securities as of June 21,2000; June 19,2003 and December 31, 2004.
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