The yield curve is the curve that shows the yield of each bond over the time horizon of different securities, plotted on a graph. The yield curve provides a clear picture of long-term bonds versus short-term bonds at different points in time.
Flat Yield Curve
A flat yield curve indicates that there are minimal, if any, differences between the interest rates of short-term bonds and long-term bonds of similar quality.
How the Curve Flattens
The yield curve flattens when the difference between the yields of short-term bonds and long-term bonds decreases.
Inverted Yield Curve
An inverted yield curve indicates that the interest rates on short-term bonds are higher than the interest rates on long-term bonds. An inverted yield curve typically precedes a period of economic recession.
Upward Sloping Yield Curve
The difference between the yields of short-term bonds and long-term bonds increases when the yield curve is upward sloping. An increase in this difference usually indicates investors’ expectations of rising inflation and strong economic growth.
How Can Investors Benefit from Changes in the Yield Curve?
The yield curve can be considered a tool used to gain insights related to short-term interest rates and economic growth. It can be effectively used to guide investors, but it is not necessarily a definitive prediction.
Note: The yield curve should be used as an investment tool alongside other tools for assessing investments. Most bond investors prefer to follow a stable long-term approach based on specific goals instead of being concerned with technical matters like changes in the yield curve. However, short-term investors can benefit from changes in the yield curve by purchasing some traded products with small trading volumes such as iPath US Treasury Flattener ETN (FLAT) or iPath US Treasury Steepener ETN (STPP). These two opposing types of investments provide a good way to monitor the yield curve and achieve a small profit if you are inclined to start investing in bonds.
Frequently Asked Questions (FAQs)
How is bond yield calculated?
To calculate the current bond yield, divide the annual interest payments by the bond’s value. If payments are made quarterly or monthly, you can estimate the annual interest income by multiplying the last payment. For example, if the bond is worth $1,000 and pays $10 every quarter, the yield is 4% (40 ÷ 1000 = 0.04).
What is yield curve control?
Yield curve control refers to the strategy of capping interest rates on a range of securities to influence the slope of the yield curve. Central banks impose these price limits by purchasing securities directly to rein in prices.
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Source: https://www.thebalancemoney.com/steepening-and-flattening-yield-curve-416920
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