gen-define-the-yield-curve-and-give-one-short-worked-example-17bf

Define the yield curve and give one short worked example.

# Yield Curve ## Definition The **yield curve** is a graphical representation that plots interest rates (yields) of bonds having equal credit quality but different maturity dates. It shows the relationship between the interest rate (or cost of borrowing) and the time to maturity of the debt. **Key characteristics:** - X-axis: Time to maturity (e.g., 3 months, 2 years, 10 years, 30 years) - Y-axis: Yield/Interest rate (%) - Typically uses government bonds (like U.S. Treasuries) **Common shapes:** - **Normal (upward sloping)**: Longer maturities have higher yields - **Inverted (downward sloping)**: Shorter maturities have higher yields - **Flat**: Similar yields across all maturities --- ## Worked Example **Scenario:** You observe the following U.S. Treasury yields on a given day: | Maturity | Yield | |----------|-------| | 3-month | 2.0% | | 2-year | 2.5% | | 5-year | 3.0% | | 10-year | 3.3% | | 30-year | 3.5% | **Analysis:** This is a **normal yield curve** (upward sloping) because yields increase with maturity. **Interpretation:** - Investors demand higher returns for lending money for longer periods (compensation for inflation risk and uncertainty) - Suggests healthy economic expectations - The difference between 3-month (2.0%) and 30-year (3.5%) is 1.5%, called the "yield spread" This normal curve suggests the market expects stable economic growth.