Understanding Bonds - Question 100

On cable TV they talk a lot about the yield curve being normal or inverted. What does this mean and why is it important?

A yield curve is a graph that plots interest rates for a security that is issued with different maturity lengths. Yield curves can be plotted for municipal bonds, corporate bonds and treasury securities. (Interest rate is measured on the vertical axis and the time period on the horizontal axis.)

The yield curve that is generally referred to on TV is the yield curve for Treasury securities. It usually slopes upward because interest rates are higher as maturity lengths increase. This is what is called a "positive" or "normal" yield curve.

When short-term interest rates shoot up because of inflation fears, the yield curve slopes downward because longer-term maturities have lower rates. The yield curve in this scenario is called “inverted.”

In rare instances, short-term and long-term interest rates are almost equal. The yield curve is then called “flat.”