Bond interest rates are shown graphically in the form of a yield curve. The shape of a yield curve, which can be normal, inverted, or flat depending on the structure of the underlying term structure, is a leading indicator of where interest rates are likely to move in the future.

If you have the bond maturities and their yields to maturity, you can use Excel to generate a yield curve. The yield to maturities is plotted along the y-axis of a yield curve graph, while the time until maturity occupies the x-axis.

Exactly What Is A Yield Curve?

The yield curve is a line charting the relationship between the yields on bonds of similar quality and maturity. If you look at the incline of the yield curve, you can predict future interest rate shifts and GDP growth. Normal, inverted, and flat yield curves are the three most common.

The Functioning of a Yield Curve

Changes in economic output and growth can be predicted with the help of a yield curve, which serves as a standard against which other debt in the market can be measured. The most commonly discussed yield curve compares U.S.

Treasuries with maturities of three months, two years, five years, ten years, and thirty years. Each trading day's yield curve rates are posted on the Treasury's interest rate websites by 6:00 p.m. ET.

Indicative of an impending economic downturn, an "inverted yield curve" occurs when the rates on shorter-term bonds are higher than those on longer-term bonds. Short-term and long-term yields indicate an economic shift when the yield curve is flat or humped.

Various Yield Curves

Regular Yield Curve

As indicated by a normal or upwardly sloped yield curve, bond yields for the longer term are likely to continue rising in response to economic expansion. As a result, the yields on bonds with shorter maturities tend to be lower than those with longer maturities, and the yield curve typically slopes upwards.

Let's pretend for the sake of argument that bonds of varying maturities offer varying rates of return, such as 1% for a 2-year bond, 1.8% for a 5-year bond, 2.5% for a 10-year bond, 3.0% for a 15-year bond, and 3.5% for a 20-year bond.

Inverted Yield Curve

Instead, short-term interest rates are higher than long-term rates when the yield curve is inverted. This yield curve is typical during economic downturns when bond investors anticipate further drops in yield for bonds with longer maturities. 1 The yield on long-term bonds is lower because their price rises during economic downturns when investors buy them over short-term bonds.

The Yield Curve is Flat

When yields at all maturities are roughly the same, we say the yield curve is flat. There may be a small bump in the otherwise flat yield curve at intermediate maturities where yields are slightly higher than average.

Mid-term maturities typically have these bumps. The term "flat" refers to the fact that the yield to maturity of bonds of varying maturities does not vary significantly. Interest rates on bonds of different maturities can vary widely.

An unstable economic climate is indicated by a yield curve that is flat or humped. It might occur towards the conclusion of a period of rapid economic expansion that has caused inflation and slowed-growth anxieties.

The Five-Step Process of Deriving a Yield Curve

1. To do this, open a new spreadsheet in Microsoft Excel and type "U.S. Treasury Bond' Time to Maturity" in cell A1 and "U.S. Treasury Bond' Yield to Maturity" in cell B1.
2. Then, in columns A2, A3, A4, and A5, type 10, 20, and 30, and in column A6, enter 2.
3. Cell B2 should have 2.5%, cell B3 should have 2.9%, cell B4 should have 3.3%, cell B5 should have 3.6%, and cell B6 should have 3.9%.
4. Select Rows 2 through 6, Columns 2 through 6, and click the Insert button. You can find Scatter under the Charts menu, where you may then choose Scatter with Smooth Lines and Markers.
5. Finally, pick Axis Titles from the Chart Elements menu after clicking the chart. The label for the horizontal axis should read "Time to Maturity (In Years)," while the title for the vertical axis should read "Yields." Fill the Chart Title with "Yield Curve for U.S. Treasury Bonds."

The ensuing yield curve for these U.S. T-bonds is typical, with a concave down (rising) shape as rates rise with increasing time till maturity.