Let's start with answering the question what a yield curve actually is. Now the concept is relatively simple. A yield curve is a graphical display of bond yields for different maturities and usually the yield to maturity i.e. YTM is used. When putting a yield curve together, however, care must be taken as all bonds used must have the same issuer and credit quality. So for example, only youth US treasuries. If this is not the case the yield curve becomes inconsistent and provides little value. This graph shown here is the US Treasury yield curve as of the beginning of March, 2019. And as you can see, rather than using all available US government bonds, practitioners usually focus on a limited range of key maturities which are also referred to as benchmark maturities.

Yield curves come in all forms and shapes, but there are three main types that you should be familiar with. The first one is what's called the normal yield curve. It is outward sloping, which means that yields increase with time to maturity. And this actually is quite intuitive as the risk for a bond holder rises with increasing time to maturity and so should the return, in other words, a yield. So it's not surprising that yield curves are normally upward sloping which is why this shape is referred to as a normal shape. Inverted yield curves are downward sloping, yields for short dated bonds are higher than yields for longer dated bonds. This cannot be explained with risk aversion as in case of the normal shape but there is an intuitive explanation for the shape as well. If investors expect yields to decline significantly over the next few months let's say, they will prefer longer dated bonds as these will enable them to lock in the current yield levels for longer. This will lead to an increase in long-term bond prices and in turn to a decline of long-term yields to a level below the level of short-term yields. The third type is referred to as a flat yield curve. In case of a flat yield curve, yields for all maturities simply trade at very similar levels so that the yield curve looks like a flat line. In general, yield curves are snapshots of yields for different maturities at a particular point in time but in the same way that yields for individual bonds move when demand and supply changes, yield curves can be quite volatile as well and move from normal to inverted shape and vice versa. The chart shown now again shows the US Treasury yield curve but at different points in time. At the beginning of March, 2019, 2018 and 2017. As you can see, the level of yields for the same maturity have stiffened significantly over the observed timeframe and the largest changes have occurred in the shorter maturities. Since 2017, the yields for the one month maturity for example, have risen from around 0.5% to around 2.5%. While the yields for 30 immaturities have virtually remained unchanged with a result that the difference between short term and longer term yields has decreased. Practitioners refer to this as yield curve flattening, and the opposite movement, by the way, would be referred to as yield curve steepening. But the important question then of course is what drives the shape of a yield curve? Well, there are many series out there that attempt to explain yield curve shapes but none has yet been able to explain all observable shapes. In practice, yield curves are driven by a large variety of factors. Let's have a look at a few examples. First, there are the expectations of market participants, for example, regarding future level of interest rates or inflation. And when these expectations change, bonds with certain maturities might see an increased demand whereas bonds with other maturities might see increased supply when investors try to sell them. Second, there's the supply side. Imagine the government announces to issue a lot less longer dated bonds than previously. As there are investors who need to invest in these bonds for asset liability management purposes. This announcement could lead to rush by these investors into the long dated bonds that are in existence which will drive up the price and drive down the yields for the longer dated bonds. And last but not least, there's the demand side. If the overall demand for bond investments increases, but the volume of available bonds remain stable, this inflow of liquidity will drive up bond prices and lead to a change in yield curve shape.