Certified Financial Management Specialist Practice Exam

What does the yield curve represent?

1. Graph showing relationship between interest rates and maturities

2. Cost of borrowing money expressed as a percentage

3. Central bank actions to control money supply

4. Overconfidence in one's own knowledge or skills

The correct answer is: Graph showing relationship between interest rates and maturities

The yield curve represents a graphical depiction that shows the relationship between interest rates and the time to maturity for debt securities, typically government bonds. This curve illustrates how the interest rates (or yields) change based on the maturities of the securities, from short-term to long-term. Understanding the yield curve provides insightful information about market conditions. For instance, a normal upward-sloping curve indicates that longer-term debt instruments typically have higher yields compared to short-term ones, reflecting the risks associated with time, such as inflation and uncertainty about the future. Conversely, an inverted yield curve, where short-term rates are higher than long-term rates, can signal potential economic downturns or recessions. The other answer choices pertain to different financial concepts. The cost of borrowing money expressed as a percentage is effectively the interest rate itself, which is influenced by, but not represented by, the yield curve. Central bank actions to control the money supply relate to monetary policy tools and practices, which impact interest rates but do not define the yield curve itself. Lastly, overconfidence in one's own knowledge or skills is a psychological bias and does not relate to financial graphs or rates, making it irrelevant in this context.