InvestorQ : I recently learnt that the US yield curve as inverted. What does the yield curve mean and why is it important to bonds?
Niraj Mehta made post

I recently learnt that the US yield curve as inverted. What does the yield curve mean and why is it important to bonds?

Answer
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Niraja Mehta answered.
1 year ago


To understand the yield curve, you need to understand the term structure of interest rates. The term structure is all about yields on bonds of different tenures. Logically, a 5 year bond will require a higher yield than a 3 year bond as the risk on a 5-year bond is higher than on a 3 year bond. This will continue as you go up on the term to maturity scale. This relationship is called the yield curve. The term structure of interest rates, therefore, refers to the relationship between the yields and maturities of a set of bonds with the same credit rating. Typically, the term structure refers to Treasury securities but it can also refer to riskier securities, such as AA bonds. A graph of the term structure of interest rates is known as a yield curve. Ideally, you should consider term structure within the same class of assets like AAA bonds, AA bonds, government securities etc so that they are actually comparable.

Consider the example below from the US markets which gives you an idea of the term structure of interest rates. Yields progressively go up as you go towards the longer end of the yield curve with larger maturities.

MATURITY

YIELD

1 month

0.25%

3 months

0.26%

6 months

0.35%

1 year

0.45%

2 years

0.61%

3 years

0.71%

5 years

1.00%

7 years

1.26%

10 years

1.46%

20 years

1.83%

30 years

2.27%