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3 Theories Explaining the Shape of the Yield Curve [Video]

3 Theories Explaining the Shape of the Yield Curve

There are three theories to explain the shape of the yield curve.

Expectation theory says the long-term yield of a financial instrument is the average of the short-term yields that are expected to occur over the life of the instrument. Thus:
• An upward yield curve means investors expect short-term yields to rise in the future
• A downward yield curve means investors expect short-term yields to decline in the future

The yield curve, therefore, changes as investors’ expectations about future short-term yields change. This explains why yields with different maturities tend to move together.

Market segmentation theory says that yields for different terms are based on supply and demand. In short, some investors have a preference for financial instruments with a certain maturity, and these preferences determine yields. The downside of market segmentation theory is that it fails to explain why yields with different maturities tend to move together.

Liquidity premium theory is a combination of expectations theory and market segmentation theory. According to this theory, the long-term yield is the average of short-term yields throughout the life of the bond plus a liquidity premium that represents the supply and demand for bonds at that term.

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Resources for Accountants

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Resources for Accountants

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Advanced Issues and Disclosures [Video]

This is the introductory video to our self-study eLearning course "Business Combinations: Advanced Issues and Disclosures." Check it out here: https://www.gaapdynamics.com/product/business-combinations-advanced-issues-and-disclosures/ This is the second course of the three-part Business Combinations eLearning series. Now that you are familiar with the basic accounting rules, this course dives deeper into more advanced business combination issues such as exceptions to general guidelines, noncontrolling interests, and measurement period adjustments. Learn more about GAAP Dynamics: https://www.gaapdynamics.com/ Check out our other online courses on the GAAP Dynamics Learning Library: https://www.gaapdynamics.com/individual-learning/ Subscribe to GAAP Dynamics to see more videos like these!