The yield curve is a graph showing the relationship between bond yields and maturities. This particular U.S.

Treasury yield curve is an upward-sloping, or normal, yield curve. The shape of the yield curve indicates that short-term interest rates were lower than long-term interest rates. The upward-sloping yield curve is considered the usual situation in the market because short-term securities have less interest rate risk than longer-term securities and, thus, a smaller Maturity Risk Premium (MRP). Therefore, short-term rates are typically lower than long-term rates. There are two primary theories that explain the factors which determine the shape of the yield curve: (1) the pure expectations theory and (2) the liquidity preference theory. The pure expectations theory states that the shape of the yield curve depends on investors expectations about future interest rates. According to the pure expectations theory, long-term interest rates are a weighted average of current and expected future short-term interest rates. In addition, investors are indifferent with respect to maturity in the sense that they do not view long-term bonds as being riskier than short-term bonds. Therefore, the Maturity Risk Premium (MRP) is equal to zero under the pure expectations theory. The pure expectations theory would suggest that this particular U.S. Treasury yield curve is upward-sloping because interest rates are expected to increase in the future. This increase could be due to an increase in expected inflation or to an increase in the expected real risk-free rate. The liquidity preference theory states that lenders, other things held constant, would prefer to make short-term loans rather than long-term loans because such securities are more liquid in the sense that they can be converted to cash with little danger of loss of principal. Therefore, investors will generally accept lower yields on short-term securities, which leads to relatively low short-term rates. Borrowers, however, generally prefer long-term debt because

short-term debt exposes them to the risk of having to repay the debt under adverse conditions. Borrowers are willing to pay a higher rate, other things held constant, for long-term finds, which also leads to relatively low short-term rates. Thus, lender and borrower liquidity preferences cause short-term rates to be lower than long-term rates. The liquidity preferences theory would suggest that this particular U.S. Treasury yield curve is upward-sloping because a positive Maturity Risk Premium (MRP) exists and the MRP increases with years to maturity, causing the yield curve to be upward-sloping.