A yield curve is a graph plotting interest rates for the same type of bond for a series of maturities, typically ranging from three months to over 25 years. Although yield curves can be plotted for any type of bond, they are most commonly seen for Treasury securities.

Bond investors typically use yield curves to help find a maturity that maximizes return at an acceptable risk level. For instance, you may find increasing a bond's maturity by a couple of years will increase return significantly or committing funds for a long time does not bring much additional return.

Economists study yield curves to help predict inflation, interest rates, and recessions. To do so, you need to understand what the various shapes in the yield curve indicate about the economy:

• The yield curve's normal shape is upward sloping, since interest rates usually rise as the bond's maturity increases. An upward sloping yield curve indicates investors believe the economy is healthy and do not expect interest rates or inflation to increase significantly in the near future. The spread between a three-month Treasury bill and a 20-year Treasury bond is typically 3% (Source: AAII Journal, May 2003).
• A steep upward sloping yield curve indicates investors believe the economy will improve quickly in the future and is typically seen at the beginning of an economic expansion. Short-term rates are typically depressed due to a recent recession. Once economic activity starts to pick up and demand for capital increases, short-term rates typically increase so the curve becomes less steep.
• A flat yield curve occurs when short- and long-term rates are almost the same. It generally indicates that an economic slowdown and lower interest rates will follow.
• An inverted yield curve occurs when short-term interest rates are higher than long-term rates and is an indicator that a recession is likely to follow. This type of yield curve typically means the Federal Reserve is increasing short-term rates in an attempt to slow the economy or investors are locking in long-term rates in anticipation of an economic downturn.

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