If you don’t understand the Yield, then you are the Yield

Probably the only upside of witnessing a nonsensical situation such as the one we are watching at the moment within the global economy, is that some of the most underrated and misunderstood concepts start to form part of the financial literacy of the general population.

This is the case of the concepts of Yield and Yield Curve. Basically, they are linked to Fixed Income financial instruments such as Bonds for example, but I must warn you now, even though we are talking about Fixed Income, there is nothing “Fixed” inside the mechanics of these types of instruments.

I wanted to use this delivery opportunity to share with you some basic but useful info about this concept because it is attracting a lot of attention in the Financial Mainstream Media and alternative spaces such as Crypto Twitter.

A Yield is like an Interest Rate but with the difference that an interest rate is what is used to calculate a payment you need to honor as part of a Home Loan for example. A Yield in the other hand is the theoretical return that an investor should obtain if is able to maintain a bond until the maturity date and two conditions are present: 1) The principal is paid in full by the issuer and, 2) each of the coupon payments are reinvested at the same coupon rate until maturity.

Here Duration, coupon and price paid (discount or premium) are critical to calculate the Yield. The complexities of the pricing mechanism of a Bond are outside the scope of this article but the point I want to make today is that regardless of what type of investor are you or what type of financial assets you use to trade most frequent, you must always pay close attention to the Yield Curve because it will give you a clear indication to where things are heading.

Very important if you are …well a Trader…

The Yield Curve is the graphical representation of the Yield value at certain durations from the short terms to the long-term ones.

There are four types of Yield Curves

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Normal Yield Curve

A normal yield curve has low yields for short term maturities and higher yields for higher maturities. A normal yield curve slopes upwards and flattens at the end of the curve. This is the most common type of yield curve and usually signals normal economic conditions (Not a Boom but not a recession either).

Steep Yield Curve

They are like a normal yield curve but they don’t flatten out at the end (it continues to rise instead). Generally imply a growing economic conditions accompanied by higher inflation

Flat Yield Curve

A flat yield curve has similar yields across all maturity terms. They might have some variation on the middle of the curve but its behavior is mostly flat and implies an uncertain economic forecast. It may come at the end of a high economic growth period with high inflation. It might appear when the Fed Reserve is about to raise interest rates.

Inverted Yield Curve

Is the opposite of the normal yield curve. It slopes downward. Meaning that short-term interest rates are higher than long-term rates. They are not very common, but they usually suggest a severe economic downturn. Basically, they provide a warning that a recession period is in the short horizon.

I will highly recommend you now that you know how to identify the shape of a Yield Curve and its predictive meaning, that you regularity (Daily nowadays) the shape of the lattes Yield Curve published by the Local Monetary or Financial Authority in your country (US Treasury or Fed Reserve in the case of the United States) to gather some valuable intel to be incorporated into your trading or financial plans.