Forex Investment and Currency Trading

Yield curve is used to analyze maturity risk in the credit markets. It applies to any fixed income market that has a series of maturities, such as an individual county’s debt or a series of expiration months for interest rate futures.

Yield curves are plotted for a given day or series of days.

Yield curves provide graphic representation of the maturity risk in a given market. Along with displaying a risk/reward curve for investors, it can also help identify unusual economic conditions for the issuer such as a liquidity crisis or recession.

A normal yield curve shows yields rising as maturities increase. This means that long-term investors are being compensated for taking on the additional risk. This type of Yield Curve is called “upward sloping”.

Flat yield curves occur when all maturities have the same or similar yields. This results when long-term investors see no more risk than shorter-term investors. There are many market and economic reasons why this occurs. One of them is that if interest rates in general are falling, long-term investors will get the benefits of capital appreciation and, therefore, do not require a higher current income.

Inverted yield curves result when the yields in the shorter maturities are greater than those of the longer maturities. Typically, this indicates a stressed economic condition, but it not the only reason. When there is a liquidity crisis in the economy, the interest rate cost rises.

The absolute levels of yield over the entire curve are less important than the shape of the curve. However, when two or more yield curves for different dates are overlaid in a chart, the absolute positions of the curves indicate whether interest rates in general have risen or fallen from date to date.

When the yield curves of two or more dates cross, this indicates that the general level of interest rates has stayed the same while the relationship of the different maturities has changed. The curve has “rotated”.

The chart above shows US Market yield curves. The overall level of interest rates in the US fell from February 95 (top line) to June 95 (bottom line). The February curve is steep in the short end and relatively flat in the long end indicating that investors viewed medium and long-term risk to be similar. The June curve indicates that investors viewed short and medium term risk to be similar.