Articles | January 29, 2020

The Yield Curve Explained: Why and What You Need to Know

A yield curve is a line that plots the yield rates, at a set point in time, of zero-coupon bonds with differing maturities.

Upward yield curve

An upward sloping yield curve is one in which longer-maturity bonds have a higher yield than shorter-term bonds.

This is the most common shape because longer-maturity investors generally demand a premium to compensate the additional volatility associated with longer-duration investments.

An upward sloping yield curve gives investors a sense of expected economic growth.

 


yield curve explained

Inverted yield curve

An inverted yield curve is one in which the shorter-term yields are higher than the longer-term yields.

Experience has shown an inverted yield curve has been a fairly reliable predictor of economic downturns.


inverted yield curve

Flat yield curve

A flat yield curve is one in which the shorter- and longer-term yields are very close to each other.


flat yield curve example

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What these yield curves mean for you

As a rule, the more mature a pension plan is, the more its discount rate will be reliant on the shorter-term bonds. Less mature plans are more sensitive to the longer-term yields. The effective discount rate describes how the yield curve is used to calculate a pension liability as a present value of future benefit payments.

The graph below shows how the effective discount rate changed during 2019 for two plans — a mature plan with a duration of eight years and a younger plan with a duration of 14 years. Duration measures the sensitivity of a pension plan’s liability to changes in interest rates.


effective discount rate on a model pension plan

 

See how bond yields and investment performance affect a pension plan’s funded ratio over 12 months

Every quarter, Segal and Segal Marco Advisors examine the effect of changes in the assets and liabilities of a model private sector single-employer pension plan on its funded ratio over the four most recent quarters, viewing such changes through a marked-to-market lens.

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This page is for informational purposes only and does not constitute legal, tax or investment advice. You are encouraged to discuss the issues raised here with your legal, tax and other advisors before determining how the issues apply to your specific situations.

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