Definition of 'Yield Curve'

A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates. The most frequently reported yield curve compares the three-month, twoyear, five-year and 30-year U.S. Treasury debt. This yield curve is used as a benchmark for other debt in the market, such as mortgage rates or bank lending rates. The curve is also used to predict changes in economic output and growth.

WHAT IT IS?:The yield curve, also known as the "term structure of interest rates," is a graph that plots the yields of similar-quality bonds against their maturities, ranging from shortest to longest. (Note that the chart does not plot coupon rates against a range of maturities -- that's called a spot curve.)

How It Works/Example:
The yield curve shows the various yields that are currently being offered on bonds of different maturities. It enables investors at a quick glance to compare the yields offered by short-term, medium-term and long-term bonds. The yield curve can take three primary shapes. If short-term yields are lower than long-term yields (the line is sloping upwards), then the curve is referred to a positive (or "normal") yield curve. Below you'll find an example of a normal yield curve:

If short-term yields are higher than long-term yields (the line is sloping downwards), then the curve is referred to as an inverted (or "negative") yield curve. Below you'll find an example of an inverted yield curve:

Finally, a flat yield curve exists when there is little or no difference between short- and long-term yields. Below you'll find an example of a flat yield curve:

It is important that only bonds of similar risk are plotted on the same yield curve. The most common type of yield curve plots Treasury securities because they are considered risk-free and are thus a benchmark for determining the yield on other types of debt. The shape of the yield curve changes over time. Investors who are able to predict how the yield curve will change can invest accordingly and take advantage of the corresponding change in bond prices. Yield curves are calculated and published by The Wall Street Journal, the Federal Reserve, and a variety of other financial institutions.