Excerpted from October 28, 2005, Solutions News Bulletin
By John Grant, CFC Senior Consultant, Financial Advisory Services
Of key interest to financial managers are interest rates for various maturities, also known as the yield curve. An understanding of the yield curve helps managers make better-educated decisions regarding their loan portfolios.
Historic yield curves have taken on many shapes, including normal, humped, flat and inverted.
Many theories exist to explain the underlying reason that causes a particular shape. Three of the most widely cited theories are expectations theory, liquidity preference theory and market segmentation theory. Each will be explained in a series of articles in Solutions.
The expectations theory says the yield curve shape is derived from the market’s expectations about future interest rates. Conversely, looking at the shape of the yield curve can tell us a lot about where future rates are headed.
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