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Consider a situation where the Treasury yield curve has a steep upward slope, with short-term yields...

Consider a situation where the Treasury yield curve has a steep upward slope, with short-term yields of approximately 4% and long-term yields of more than 8%. Explain how this pattern might occur.

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Answer #1

The yield curve is generally upward sloping. This means that investors demand a higher yield on bonds with higher maturity than bonds with lower maturity. This is because there is a higher risk of holding the bonds with higher maturity than the same bonds with lower maturity, due to associated risk of time and hence, a risk premium is higher in case of higher maturity bonds. Hence, for shorter term yield is approximately 4% and for longer terms yield is more than 8% due to the higher risk associated with higher maturity bonds.

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