Bonds uncovered: What is a yield curve?

Julie Brownlee, Fsp Invest, 27 Oct. 2014

Tags: yield curve, yield curves, chart of a yield curve, what is a yield curve, what yield curves show, bonds,



If you’ve looked into buying bonds, you might have come across a yield curve.

Yield curves actually have a bearing on the interest rates you get for loans from your bank, so it’s worthwhile getting to grips with how they work.

So what is a yield curve? And how does it work?

Let’s take a closer look…



The ins and outs of a yield curve


A yield curve plots the interest rates offered on a borrower’s bonds against their maturity dates.

The interest rate on a yield curve is the redemption rate of the bond. It shows the timing of all future interest payments and the return of the amount borrowed.

Investors are most interested in the yield curves of government bonds. When banks set the interest rates of loans and mortgages, they use yield curves.


How a yield curve works


When you look at a yield curve, you tend to see the curve sloping upwards from left to right. This is because bonds with longer maturities tend to have higher interest rates.

The reason for this is that longer-term holders of bonds are at higher risk to changing interest rates, inflation and the chance of the borrower not paying back the bond amount.

Have a look at the chart below from investing.com. It shows you the South African government’s yield curve…


Chart of South African government bond yield curve



How professional investors use yield curves


Professional investors closely study the shapes of yield curves. This is because they can try to profit from changes in them. Or at the very least, avoid losing money.

If you see a yield curve that’s trending down from left to right, this can indicate a recession. This is because the market expects interest rate cuts in the future to try to stimulate the economy.

Yield curves like this are known as downward sloping yield curves or inverted yield curves.

Some professional investors actually look for yield curves like this.

For example, pension fund managers. This is because they’re looking for long-maturity assets that match their long-term liabilities of paying their members’ pensions.

So there you have it, what a yield curve is.

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