Yield Curve

Yield curve is a graph that shows the relationship between yield to maturity of bonds (in percentage) and their maturity (in years). In such a graph, yield to maturity (YTM) of the bonds is plotted on the vertical axis and the corresponding years to maturity are plotted on the horizontal axis.

Types of Yield Curve

There are four different types of yield curves depending on their shape, namely, the normal yield curve, the steep curve, the flat yield curve and the inverted yield curve.

Yield Curve Theories

There are different theories that attempt to explain the different shapes of the yield curve, namely, the pure expectations theory, the liquidity premium theory, the market segmentation theory and the preferred habitat theory.

Example

We can develop a yield curve for yield on treasury securities (such a curve is called treasury yield curve) once we have the yield data for each maturity (it can be obtained from US Department of Treasury website).

As at 27 December 2012, the rates are as follows:

Maturity (in years)0.080.250.512357102030
Yield (in %)00.010.10.150.270.360.721.151.732.472.88

If we plot these on a graph, we get the following curve:

Yield Curve Chart

Written by Obaidullah Jan