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Yield Curve Bonds

In investments, the yield curve is a representative graph of the rates of bonds depending on whether those bonds will reach maturity in the short term or the long term. The curve ends with the bonds' maturity rate at the time when the each bond is due to be paid in full. The maturity time normally runs from six months to thirty years, though that may vary depending on the outstanding bonds in the secondary market.

The line on a yield curve graph plots the interest rate of bonds at set times and gives the relation between the interest rate to be paid to the bond holder and the time to the maturity of the bond. Sometimes this graph curve is referred to as the term structure of interest rates.

In mathematical terms, investing for a period of time is expressed as Y(t), where Y is the yield and t is the time. This is the yield curve and usually, but not always, depicts an increasing rate.

The most common yield curve used to compare bonds is the yield curve of U.S. Government Treasury bonds. This curve measures the three-month, two-year, five-year, and thirty year U.S. Treasury debt. This curve can be used to compare other lesser quality bonds, and is used as a benchmark for other kinds of debt including mortgage rates and bank loan rates. The curve is also used to predict changes in the economy and estimate economic growth.

When the economy is in a recession and the inflation rate is low, the small amount of economic growth keeps the level of rates low and the yield curve climbs gradually to reward investors who buy the longer maturing bonds. If the economy were to improve, the interest rates on short term bonds would increase more steeply than the longer term bond rates. When the short term rates rise above the long term rates, the Federal Reserve Bank may become worried about inflation and raise interest rates on loans in order to make the purchase of longer term bonds more attractive. This generally has the effect of slowing down the economy.

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