Concept of Yield Curve

The concept of yield curve basically tries to explain how the yield from the bonds changes with the changes in the date of maturity. The concept of yield curve is extremely important in the context of finance and economics.
The concept of yield curve specifies that the bonds being considered while making the yield curve should have the same quality of credit.
Uses of the Concept of Yield Curve

The concept of yield curve is used for the comparison of the following debt securities that are available especially in the United States of America:

Treasury securities having maturity periods of thirty years
Treasury securities having maturity periods of three months

Treasury securities having maturity periods of five years
Treasury securities having maturity periods of two years

The concept of yield curve has also been used in the role of standard to compare other forms of debt that are available in the market. Some common examples would be the rates of interest of mortgages and the rates at which banks provide loans.

The economists and financial planners have also employed the concept of yield curve to make forecasts about the alterations that may take place in economic production as well as economic growth. The shape of yield curve is especially useful when it comes to form an idea about the alterations in rates of interest to be expected in the future.
Types of Shape of Yield Curves
There are three primary shapes of yield curves:
Normal Yield Curves
Flat or Humped Curves
Inverted Yield Curves

Normal Yield Curves

In a normal yield curve the bonds that have a long maturity period are shown to produce better yields when compared to bonds that have short term periods. The main reason behind this are the risks that are related with the time period of these bonds.

Inverted Yield Curve

In the case of inverted yield curves the short-term bonds are shown to have higher yields than the long-term bonds. However, such a curve shows possibilities of an impending decline in the economy.

Flat or Humped Curve

In case of the flat or humped curves the yields of the bonds with longer term periods and short term periods are shown to be almost similar. The flat or humped curves normally show a period of changeover in the economy.

More Information Related to Finance Theory
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Liquidity Risk Commodity Risk Consumer Credit Risk
Systemic Risk Currency Risk Market Risk
Interest Rate Risk Settlement Risk Equity Risk
Gordon Model Monte Carlo Option Model Ho Lee Model
Rendleman Bartter Model Vasicek Model Hull White Model
Rational Choice Theory Modern Portfolio Theory Cumulative Prospect Theory
Efficient Market Hypothesis Arrow Debreu Model International Fisher Effect
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Personal Budget Floating Exchange Rate Discount Rate

Last Updated on : 1st July 2013

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