Series 3: 2.1.1.4. Yield Curves

2.1.1.4. Yield Curves

Fluctuating interest rates subject bonds to interest rate risk. Interest rate risk is the risk that when interest rates rise, the value of the bond will fall, and a bondholder who wishes to sell must take a capital loss on his investment. Bonds with longer maturities are more vulnerable to interest rate risk than bonds with shorter maturities because there is a greater chance that interest rates will rise over the bond’s life. Thus, bonds with longer maturities normally pay higher yields than bonds with shorter maturities. This tendency is represented by the normal yield curve depicted below—yield is on the y-axis and maturity is on the x-axis.

Occasionally, a situation can arise where the