Bond Yield Curve

The yield curve is a graph that plots the yields of bonds with the same credit quality but different maturities to measure and anticipate market conditions. When the curve is positive, or normal, longer-term bonds are paying higher interest rates than shorter-term bonds, and the curve slopes upward from the left. When longer-term bonds are paying lower interest rates than shorter-term bonds, the curve is said to be negative, or inverted, and the curve slopes downward from the left, though this situation is more rare. When the yield curve is flat, there is little difference between the yields of longer- and shorter-term bonds. Because U.S. Treasury issues of different maturities all have the same credit risk, returns on those short-term bills and long-term bonds are generally used to construct the graph.

Analysts study the changing yield curve to estimate the direction interest rates are headed.

There are three main types of bond yields:

Nominal Yield - The interest rate stated on the face of a bond, it represents the percentage of interest to be paid by the issuer on the face value of the bond.

Current Yield - Annual income (interest or dividends) divided by the current price of the security.

Yield to Maturity - The rate of return anticipated on a bond if it is held until the maturity date. YTM is considered a long-term bond yield expressed as an annual rate.The calculation of YTM takes into account the current market price, par value, coupon interest rate and time to maturity.It is also assumes that all coupons are reinvested at the same rate. Sometimes this is referred to as 'yield'.