Analysis of Asset Allocation

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Bonds - Yield Curves
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DEFINITION

A yield curve is a graphic representation of the relationship between yield and maturity of securities. The yield curve captures the relationship between yield and maturity at a certain moment in time. The shape of the curve changes over time.

To be representative, the instruments plotted on the yield curve must have common characteristics, such as same credit risk and same tax treatment.

Yield curves are used to compare yields of different securities, to benchmark rates and to discover yield curve aberrations.

SOME YIELD CURVE SHAPES

The yield curve can have a variety of shapes. Most common a represented below:

 

Yield Curve Description
Ascending Yield Curve

This is the common shape in developed countries. It shows that yield rises for longer maturities.

Descending Yield Curve

This shape shows that short term interest rates are higher than long term rates. This shape is often seen when the market expects interest rates to fall.

Flat Yield Curve

Short term rates are the same as long term rates.

Humped Yield Curve

Shape often seen when the market expects that interest rates will first rise (fall) during a period and fall (rise) during another.

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