Yield Curve 101

For the physician-investor who isuncertain about terminology in the financialworld, a yield curve is a line thatmaps out the correlation between theinterest rates of bonds with equal creditquality at a defined time and the maturityof the debt for the borrower. The mostcommon curve compares the 3-month,2-year, 5-year, and 30-year Treasurydebt. A bond yield is equivalent to thepercentage of interest the bank pays. Ayield curve traditionally has a positiveupward slope because long-term bondinterest rates are usually higher thanshort-term bond interest rates.

This customary curve is known as anormal yield curve. There are also threeother types of curves: steep, inverted,and flat. When the gap between the20-year Treasury bond yields and 3-month Treasury yields increases significantly,you get a steep yield curve.With this type of curve, the economy isexpected to recover swiftly. The invertedyield curve is the curve discussed inthe article, in which shorter-term yieldsare higher than longer-term yields—abad sign. A flat yield curve is a curve inwhich both short-and long-term yieldsare nearly similar, another forecaster ofan economic shift, usually a sign ofuncertainty in the economy.