Liquidity Spreads and Yield Curves
A yield curve is a line that plots the interest rates of bonds having equal credit quality but differing maturity dates for a given point of time. Bonds with longer maturities tend to pay higher yields than bonds with shorter maturities. This is represented by a typical yield curve. Yield is on the y-axis and length of maturity on the x-axis. Long-term bonds generally offer higher yields because they carry higher risk than short-term bonds.
A yield curve can reflect investors’ views on the future. If investors see the future as particularly volatile or uncertain, the spread between long- and short-term bonds widens. This makes for a steeper yield curve. Investors demand to be compensated, in the form of higher yields, for the increased uncertainty of longer maturities. In contrast, when
