UNIT 2: FINANCIAL MARKETS AND INTEREST RATES

FINANCIAL MARKETS AND INTEREST RATES 2-11

The vertical axis represents the interest rate; the horizontal axis
represents the number of years to maturity for the security. For
instance, the interest rate paid to an investor on a one-year security
in March of 1980 is 14% and the rate for a 20-year bond in January
of 1987 is 7.6%. We have not plotted every point exactly, but we
have plotted several common maturities and smoothed the curves to
illustrate the trends.

Fig. 2.1: Yield Curves for Two Different Maturities

Normal /
abnormal yield
curves

Let's examine the characteristics of the two curves. In March of 1980,
all interest rates were at relatively high levels -- with long-
term rates lower than short-term rates. The January 1987 curve has
overall lower rates, with long-term rates slightly higher than short-
term rates. An upward sloping yield curve is often called a normal
yield curve, whereas a downward sloping yield curve is called an
abnormal (inverted) yield curve.

Fundamentals of Business