Yield Curve Bonds

 

 

Yield curve bonds are a graphical illustration of the relationship between maturity of bonds and the yield at a given point of time. It is one of the most popular methods of valuing bonds. Yield curve is also used to predict future interest rates of bonds, given the current market conditions. The shape of the curve can change over time, indicating the changing outlook of a particular economy. The US Treasury bond yield is considered to be the bench mark for fixed income securities, since these Treasury bonds are risk-free. Economists use the yield curve to predict trends in economies, in general, and fixed income securities in particular.[br]  

Yield Curve Bonds – Types

 

Broadly, yield curve bonds can be classified into three types based on their shape.

 

Normal Yield Curve: When the market conditions are normal, the yield curve bonds take a positive slope. This is because there are no major changes in inflation rate, and the economy is growing at a normal rate. In these conditions, yield for long-term bonds are higher than for short-term bonds, because long-term bonds are riskier than short-term ones. Generally, when interest rates increase, bond prices decrease and the yield increase.

 

Flat Yield Curve: If the yield curve bonds are flat, it sends mixed signals to the market. It becomes difficult for investors to predict the direction of movement of the yield curve. In such scenarios, investors must preferably choose bonds or fixed income securities that have the least risk level or the highest credit quality. 

 

Inverted Yield Curve: Such yield curve bonds are observed when the market conditions are abnormal. In this scenario, the yield from short-term bonds is likely to be higher than long-term bonds. This also indicates that the interest rates in the economy, in general, will decline.[br]

 

To conclude, yield curve bonds depict how the yield of a bond is related to its maturity period. If you look at the curve carefully, you can determine whether you are sufficiently compensated for the risks you are taking with your bond portfolio. The curve will help you in choosing the right portfolio of bonds or fixed income securities for your needs.