What are Yield Curves?
The following is an explanation of what yield curves are. We will also touch on the different types of yield curve and what they indicate to the investor. This article is relevant to takers of the CII CF1, R01, R02, R06, AF4 and AF5 exams.
What is a Yield Curve?
A yield curve is a line that plots interest rates available on bonds against their maturity dates – either those offered by the government or companies.
To draw a yield curve, all you have to do is plot the number of years along the x-axis and the bond redemption yields on the y-axis, then put a dot for as many bonds as you can find and join them together.
A yield curve generally slopes upwards from left to right, because longer-dated bonds usually have higher interest rates as demanded by the investor for the risks they’re exposed to over a longer period of time, and shorter-dated bonds offer the lowest returns. This is known as a ‘normal’ yield curve. A normal yield curve shows that investors expect the economy to grow at a normal pace without any major changes in inflation rates.
The important yield curve to watch is those for gilts, as these set the interest rates on mortgages and bank loans.Some useful info on Yield Curves for your #CII #R02 exam revision. Click To Tweet
Inverted Yield Curve
Occasionally you might get an ‘inverted’ yield curve. They are rare but should not be ignored by investors. This is when shorter-term yields are actually higher than the longer-term yields, which begs the question of why longer-term investors would accept lower returns than short-term investors who take on less risk. The reason is that inverted curves can be an indication that the market is expecting longer-term interest rates to be lower (so investors lock in before they fall even lower), which can often be associated with economic slow-down or worse-case scenario, recession.
Flat Yield Curve
When short-term rates are closer to long-term rates, we get what’s called a flat yield curve. This can indicate stability in terms of inflation and interest rates.
What do Yield Curves tell us?
Yield curves give us an idea of what to expect from investments and borrowings over various different timescales as they help determine the current and future strength of the economy. Have a look at the slope of the curve too; the greater the slope, the greater the gap between short- and long-term rates.
Daily Yield Curve Estimates
The Bank of England estimates UK yield curves on a daily basis and can be found here.
Have a look and see what the curve yield tells you today.
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