Certified Financial Management Specialist Practice Exam

What does a normal yield curve indicate?

1. Lower yields for longer maturities

2. Flat yields across all maturities

3. Higher yields for longer maturities

4. Higher short-term yields compared to long-term yields

The correct answer is: Higher yields for longer maturities

A normal yield curve, which typically slopes upwards from left to right, indicates that longer-term debt securities usually have higher yields compared to shorter-term ones. This phenomenon is primarily due to the risks associated with time. Longer maturities come with increased uncertainty regarding inflation, interest rates, and the creditworthiness of borrowers over time. To compensate investors for taking on these additional risks, issuers often offer higher yields for longer-term securities. When considering the nature of the yield curve, an upward-sloping curve signifies that investors demand a premium for locking their money away for extended periods. This expectation of higher yields for longer maturities aligns with the typical behavior of financial markets, reflecting the time value of money and the need for risk compensation. In contrast, lower yields for longer maturities would imply an inverted yield curve, which suggests economic downturn expectations, while flat yields across all maturities indicate uncertainty about future interest rates and economic conditions. Higher short-term yields compared to long-term yields would also represent an inverted yield curve scenario. Thus, a normal yield curve clearly signifies higher yields for longer maturities, reinforcing the principle of risk and return in investment.