Yield curves
In a normal yield curve environment, long-term interest rates are higher than short-term interest rates. Investors expect to be compensated with higher returns when they lend money for a longer period since they are exposed to higher default risk. The normal or positive yield curve is said to be upward sloping, as shown in the following graph:
In certain economic conditions, the yield curve can be inverted. Long-term interest rates are lower than short-term interest rates. Such a condition occurs when the supply of money is tight. Investors are willing to forgo long-term gains to preserve their wealth in the short term. During periods of high inflation, where the inflation rate exceeds the rate of coupon interests, negative interest rates may be observed. Investors are willing to pay in the short term just to secure their long-term wealth. The inverted yield curve is said to be downward sloping, as shown in the following graph:
