The yield curve may take four general shapes:
(1) upward-sloping
(2) flat
(3) downward-sloping
(4) variable
The upward yield curve is the most common, as longer terms generally have higher yields. This is because investors demand a liquidity premium for the greater risk associated with a long-term investment.
The downward yield curve is called an “inverted” yield curve. An inverted yield curve means short-term financial instruments have a higher yield than long-term instruments. The inverted yield curve doesn’t occur frequently, and it has historically preceded recessions.
A flat yield curve means there is little to no difference in yields between short-term and long-term financial instruments.
A variable yield curve can take many different shapes.
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