# Yield Curve

A Yield Curve is a graph of the yields (interest rates) of bonds with different maturities. Short terms bonds generally have a lower yield because they are most liquid.

Contents

## Three Basic Facts about Yield Curves

• Interest rates on bonds of different maturities tend to move together over time. This means that yield curves from different dates do not generally intersect.
• When short-term rates are meager, yield curves tend to have steep upward slopes. When short-term rates are very high, yield curves tend to have flat or downward slopes
• Yield curves are almost always upward sloping.

### Explanation of the Three Basic Facts

#### 1. The Expectations Hypothesis

in year bond, today = i1 year bond, today + ie1 year bond, t + 1year +…+ ie1, t (n=1) / n

Weakness – upward slope implies that interest goes up every year, not always true.

Strengths – explains why yield curves are steeply upward sloped when short-term bonds are very low and explain why interest move together.

Ex: i1, t­ = 5%, ie1, t+1 = 6%, ie1, t+2 = 7%,

Interest on a one year bond = 5%

Interest on a two-year bond = (5+6)/2 = 5.5%

Interest on a three-year bond = (5+6+7)/3 = 6%