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A corporate yield curve is a measurement of the expected returns on investment for corporate bonds over a period of time. These returns are dependent upon both the interest rates offered to investors buying the bonds and the amount of time the bonds are held, also known as their maturity. Graphing the corporate yield curve will show how the interest rates, maturity, and yields are related over a period of time, creating a curved line on the graph. It is important to measure corporate yields against risk-free Treasury bond yields, with the difference between the two known as the credit spread.
Bonds are financial instruments that are favored by investors because they return regular payments known as fixed income. In most cases, an investor buys a bond with the understanding that this price, known as the principal, will be repaid at the end of the bond's term. The investor will also receive regular interest payments for the life of the bond at a predetermined rate known as the coupon. Yield is the amount of return the investor gets from the bond. Investors in corporations must be concerned with the corporate yield curve.
This yield curve is determined by the amount of return investors get from corporate bonds as time progresses. In most cases, investors are rewarded with higher yields if they hold bonds of longer maturities instead of shorter ones. This is because the investor is taking on a greater risk that his principal will not be repaid with a long-term bond. Additionally, interest rates will likely rise over that long period of time, meaning that the investor must also be compensated for the loss of value his bond would suffer with rising rates.
Graphing the corporate yield curve requires putting the yield on the vertical axis and the maturity on the horizontal axis. A sloping line will be created as the different figures are plotted into the graph. In most cases, the corporate curve will rise up vertically before curving to a horizontal angle which then stabilizes. This is known as a normal yield curve, but deviations can occur depending on economic conditions.
When considering the corporate yield curve, it is wise to set it against a benchmark curve garnered from an investment with little risk attached. Treasury securities are generally the benchmark in this case, since they are usually backed by government money. By contrast, corporate bonds usually pay higher interest rates to investors because of the chance that the corporations could default on bond obligations. This creates a separation on a graph, known as the credit spread, between the corporate curve and the benchmark. Investors must determine if the size of the credit spread makes corporate bonds worth the risk.
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