Yield curve - Wikipedia, the free encyclopedia

# Yield curve - Wikipedia, the free encyclopedia - Your...

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Contents 1 The Yield Curve Term Structu re of Interest Rates 2 Theory 2 . 1 M a r k e t e x p e c t a t i o n s ( p u r e e x p e c t a t i
[ edit ] The US dollar yield curve as of 9 February 2005. The curve has a typical upward sloping shape. In finance , the yield curve is the relation between the interest rate (or cost of borrowing) and the maturity of the debt for a given borrower in a given currency . For example, the current U.S. dollar interest rates paid on U.S. Treasury securities for various maturities are closely watched by many traders, and are commonly plotted on a graph such as the one on the right which is informally called "the yield curve." More formal mathematical descriptions of this relation are often called the term structure of interest rates .

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The yield of a debt instrument is the annualized percentage increase in the value of the investment. For instance, a bank account that pays an interest rate of 4% per year has a 4% yield. In general the percentage per year that can be earned is dependent on the length of time that the money is invested. For example, a bank may offer a "savings rate" higher than the normal checking account rate if the customer is prepared to leave money untouched for five years. Investing for a period of time t gives a yield Y(t) . This function Y is called the yield curve . Y is often, but not always, an increasing function of t. Yield curves are used by fixed income analysts, who analyse bonds and related securities, to understand conditions in financial markets and to seek trading opportunities. Economists use the curves to understand economic conditions. The yield curve function Y is actually only known with certainty for a few specific maturity dates, the other maturities are calculated by interpolation ( see Construction of the full yield curve from market data below ).
Yield curves carry an implicit forecast of future short-term interest rates: for example if the annual yield on a 1-year bond is 5%, and on a 2-year bond is 5.5%, then the implicit yield (forward rate) in year 2 is [ edit ] Theory There are three main economic theories attempting to explain how yield varies with term (borrowing) period. Two of the theories are extreme positions, while the third attempts to find the middle ground as a combination of the former two. [ edit ] Market expectations (pure expectations) hypothesis

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This hypothesis suggests that the shape of the yield curve is based on market participants' expectations of future interest rates. These expected rates, along with an assumption that arbitrage opportunities will be minimal, is enough information to construct a complete yield curve. For example, if investors have an
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## This note was uploaded on 04/07/2010 for the course ACTSC 231 taught by Professor Chisholm during the Winter '09 term at Waterloo.

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Yield curve - Wikipedia, the free encyclopedia - Your...

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