Relationship Between Yield & Maturity
- The graphical representation of the relationship between yield and maturity is called the yield curve. The yield curve plots the current yield for debt securities from short-term debt out to long-term bonds. Debt securities are available with maturities from as short as 30 days out to 30 years. The yield at each length of maturity is what bonds at those maturities are yielding in the current bond market. The shape of the yield curve tells investors and economists what the bond market thinks of current economic conditions and interest rates.
- The bond yield curve can have three basic shapes: positive, flat and inverted. The positive yield curve has rates lower on the short maturity end of the bond market and gradually increasing as maturities get longer. This is the most common shape for the yield curve. The flat yield curve has yields at the same levels for all lengths of bond maturity. The flat yield curve occurs during the transition between a positive and inverted yield curve. The inverted yield curve happens when short-term yields are higher than the yields on longer-term debt securities.
- In times of the normal, positive-sloped yield curve, debt investors earn a higher yield for investing in debt securities with longer maturities. Bonds pay a fixed rate of interest until they mature, so long-term bond investors are tying up their capital for a longer period and are rewarded with higher yields. Investors at the short end of the yield curve have their principal returned in a shorter amount of time. These investors can reinvest at the current interest rates or invest in other types of securities.
- A strong inverted yield curve existed from 1979 through 1981. Inflation was very high and short-term yields hit 18 percent. Long-term rates also increased, but up to only 15 percent. The inverted yield curve existed because investors believed rates would eventually fall and they bought long-term bonds to lock in the higher yields. The short-term rates were the result of government policies to fight inflation. Flat yield curves existed in 1989 and again in 2000. During these periods, investor expectations about the economy were changing.
- Investors use the relationship between yield and maturity to pick debt investments based on their predictions for future interest rates. If rates are expected to decline, investments should be made in long-term bonds to lock in the current rates. If rates are rising, short-term debt will allow the principal to be reinvested at higher rates when the debt matures. Conservative investors want to own bonds with a range of securities to generate income and stable principal values in a range of interest rate environments.
