Sunday, May 04, 2008

Yield curve

In finance, the yield curve is the relation between the interest rate and cost of borrowing and the time to 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 normally 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 arrangement of interest rates.

The yield of a debt instrument is the annualized percentage increase in the worth 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 unharmed for five years. Investing for a period of time t gives a yield Y (t).

This function Y is called the yield curve, and it is often, but not always, an increasing function of t. Yield curves are used by fixed income analysts, who analyze bonds and connected securities, to understand conditions in financial markets and to seek trading opportunities. Economists make use of curves to understand economic conditions.

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