Question

Identify the different types of yield curves and explain what they indicate for the U.S economy? What is the current shape of the yield curve and why is it shaped that way?

Answer 1

Yield curve is the curve drawn by plotting the curve with yield till maturity of various government securities (bonds and treasury bills) in y axis and maturity of treasury bills and bonds of various maturities in x axis. It is used as basis for deciding loan rates, mortgage rates, etc.


Normal Yield Curve: This curve is seen during economic expansion when demand of short term bonds are more than long term bonds. As a result prices of short term bonds are more than prices of long term bonds which causes decrease in yields of short term bonds and increase in yields of long term bonds.It indicates expansion in the US economy

Inverted Yield Curve: This curve is seen during economic recession when demand of short term bonds is less than long term bonds. As a result prices of short term bonds are lower than prices of long term bonds which causes increase in yields of short term bonds and decrease in yields of long term bonds.It indicates recession in the US economy

Humped Curve: Humped curve is obtained when yields of medium term bonds increases more as compared to short term and long term bonds. This is because demand and prices of short term and long term securities are more than medium term securities.It indicates recession in medium term the US economy.

Current Yield in normal as on Aug 2020. This is because the US economy is on path of recovery and there might be economic growth in future.The probability of recession in August has decreased as compared to July