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Yield to Maturity % PRUDENTIAL INVESTMENTS, A PGIM BUSINESS FIXED INCOME PRIMER 6 An 5 educational series for today’s investor. 4 3 UNDERSTANDING YIELD CURVES 2 1 2 3 4 5 6 7 8 9 10 30 A yield curve is a line graph that illustrates the relationship between the yields Term to Maturity and maturities of fixed income securities. 7 The chart6 below shows aAA “normal” yield curve. As you can see, it is upward sloping. 5 The longest-maturity securities offer the highest returns while the shortest maturities offer the 4lowest returns. This scenario is considered “normal” because longer-term securities3 generally bear the greatest investment risks and, as a result, “should” offer 1 2 5 10 30 higher interest rates. Of course this 3is not always the case. In addition to a normal, Term to Maturity: Years upward sloping curve, a yield curve may also be inverted, or downward sloping, or it may be “humped,” as we will discuss later in this paper. Yield to Maturity % Yiled Yield to Maturity % Yield curve graphs provide a quick way to review and compare the yields that different types of fixed income securities offer, and to determine investor expectations for market conditions in the future. They are created by plotting the yields of different maturities for the same type of bond. The “spreads” between the yields9 of different maturities are what create the slope, or shape, of the yield Government curve for8a given type ofAAA security. Normal Yield Curve 8 7 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 30 Term to Maturity: Years For illustrative purposes only. prudentialfunds.com Yield to Maturity % Ask your financial professional. Inverted Yield Curve TYPES OF YIELD CURVES 7 ld to Maturity % WANT TO KNOW MORE ABOUT FIXED INCOME INVESTING? 6 5 4 3 2 1 Yield curves may be created for any type of fixed income security, including 6 5 US Treasury securities, investment-grade and high yield corporate securities, 4 global bonds, and municipal bonds. The yield curve for US Treasury securities is 3 considered a market benchmark, as it is often used as a basic reference point by 2 fixed income investors to evaluate market conditions. It is also used as a benchmark 1 0 to evaluate the relative attractiveness of investing in non-US Treasury securities. 1 2 Treasuries, 3 4 5 theory, 6 7 8 credit 9 risk, 10 so 30 the extra yield This is because US in have no Term to Maturity: Years offered by a similar maturity, non-US Treasury security should offer adequate compensation for any additional risks incurred by the investor. Humped Yield Curve FIXED INCOME PRIMER The yield curves for corporate securities are more typically known as “credit curves” because, unlike yield curves that plot the yield and maturity of a specific security, credit curves plot the yields available on a universe of corporate bonds of a specific credit quality, such as AAA-rated (the highest investment-grade credit quality) through BBB-rated (the lowest investment-grade credit quality), as well as for lower-quality, high yield bonds. Investors can also evaluate spreads from a “current vs. historical” standpoint. In other words, let’s say the spread today between a 10-year US Treasury bond vs. a 10-year AAA-rated corporate bond is +50 basis points. Is that typical? Perhaps not. Perhaps the spread was only +35 basis points a year ago. If that’s the case, the AAA-rated corporate bond, with the +50 basis points yield advantage today, looks particularly attractive. COMPARING YIELD CURVES Finally, investors also use yield curves to compare the relationship between maturities within the same type of security, such as between 2-year and 10-year US Treasury securities (often called “2s/10s” for short). In the above example, that spread is +175 basis points (4.25% vs. 6.00%). Another maturity relationship that is frequently evaluated is the spread between the ultra-short 3-month US Treasury bill versus the ultra-long 30-year US Treasury bond. This spread tells investors whether they are being paid enough in extra 6 yield to compensate them for the additional interest rate 5 associated with extending maturities within the same risks 4 of security. type One way to do this is to review the “spread,” or the difference in yields between different types of securities. The “spread” columns in the chart below show the difference between the yields on the benchmark US Treasury yield curve and the AAA- and AA-rated corporate bond curves, respectively. Investors can use this data to determine if the amount of spread available today on a AAA- or AA-rated bond offers enough additional yield over US Treasuries to make the security an attractive investment. Yield to Maturity % Comparing the yield curves of different types of securities can help investors determine the “relative value” of a bond and can also help to create strategies to increase a portfolio’s total return. Investors may wish to compare the US Treasury yield curve against AAA-rated and AA-rated corporate bonds, for example, to see how much additional yield they could capture by assuming some credit risk. (See charts below.) 3 2 1 2 3 4 5 6 7 Term to Maturity 8 9 10 Govt AAA 1-Year 4.00% 4.15% 4.45% AA 0.15% AAA AA 2-Year 4.25 4.45 4.90 0.20 0.65 0.45% 3-Year 4.50 4.75 5.20 0.25 Yiled 0.70 5-Year 5.00 5.30 5.90 0.30 0.90 10-Year 6.00 6.50 7.25 0.50 1.25 30-Year 7.00 7.70 8.50 0.70 1.50 For illustrative purposes only. 8 7 6 5 4 3 2 1 0 9 8 7 6 5 4 3 Government AAA AA 1 2 3 5 10 Term to Maturity: Years 7 6 30 Normal Yield Curve 1 2 3 4 5 6 7 8 Term to Maturity: Years ity % Spread over Govt Bonds Yield to Maturity % Yield to Maturity Yield to Maturity % US Government vs. AAA-/AA-Rated Credit Curves Inverted Yield Curve 9 10 30 30 7 FIXED INCOME PRIMER 6 5 4 10 3 30 2 1 Finally, a “humped” yield curve indicates an expectation of 0 higher rates in the middle of the maturity periods covered, 2 3investor 4 5 6 7 about 8 specific 9 10 30 perhaps1 reflecting uncertainty Term to Maturity: Years Yield to Maturity % Yield to Maturity % Inverted Yield Curve 4 3 2 2 CURVE 3 4 5A STORY 6 7 8 9 EVERY1 YIELD TELLS Term to Maturity The shape of a yield curve provides valuable information to Yield to Maturity % Yield to Maturity % economic policies or conditions, or it may reflect a transition 6 Each yield curve shape tells a different story. A normal, of the yield curve from a normal to inverted, or vice versa. upward-sloping yield curve implies that investors expect the 5 economy to grow in the future, and for this stronger growth to Humped Yield Curve 4 9 Government lead to higher inflation and higher interest rates. They will not 8 6 3 7 to purchasingAAA commit longer-term securities without getting 5 a2 higher than those offered by shorter-term 6 interest rateAA 4 51 securities. A2normal3 yield4curve 5typically 6 occurs 7 when 8 central 9 10 330 banks4 (such as the Federal Reserve the United States) are 2 Term toinMaturity 3 “easing” monetary policy, increasing the supply of money and 1 1 2 3 5 10 30 the availability of credit in the economy. 0 Term to Maturity: Years A normal yield curve signals that investors expect the economy to expand. An illustration of this is shown below. Yield to Maturity % Yield to Maturity % Yield to Maturity % investors as to what other investors believe will take place in the fixed income market in the future. 8 7 6 5 4 3 2 1 0 9 8 7 6 5 4 3 Normal Government AAA Yield Curve AA 1 2 1 2 3 4 3 5 10 5 6 Maturity: 7 8 Years 9 10 Term to 30 30 An inverted yield curve, on the other hand, occurs when longterm yields fall belowNormal short-term yields. An inverted yield curve Inverted Yield Curve Yield Curve indicates that investors expect the economy to slow or decline 87 6 future, and this slower growth may lead to lower inflation in 76the and 5 5lower interest rates for all maturities. An inverted yield 4 4 typically indicates that central banks are “tightening” curve 33 monetary policy, limiting the money supply and making credit 22 1 1available. An inverted yield curve has often historically been less 00 a harbinger of to 1 2 an 3economic 4 5recession. 6 7Investors 8 9are willing 10 30 1 2 3 4 5 6 7 8 9 10 30 accept a lower interestTerm rate now in return for being locked in for TermtotoMaturity: Maturity:Years Years years to come. An illustration of this is shown below. 7 66 5 5 4 34 23 12 01 0 Inverted Yield Curve Humped Yield Curve 1 2 1 3 2 4 5 6 7 8 9 10 30 Years 3 Term 4 to 5Maturity: 6 7 8 9 10 30 Term to Maturity: Years Humped Yield Curve 6 1 2 3 4 5 6 7 8 Term to Maturity: Years 9 10 30 CONCLUSION Term to Maturity: Years Yield to Maturity Yield to Maturity % % d 5 Yield to Maturity % Yield to Maturity % ed Term to Maturity: Years 6 Yield curves are created by illustrating the yields for a particular type of security at different maturities. The US Treasury yield curve is used as a benchmark to which yield curves for other types of bonds can be compared. The shape of the yield curve for a fixed income security reflects market factors including the direction of interest rates, risk, and investor demand. Yield curves are widely used by investors and portfolio managers as a snapshot of market conditions and to compare different investment options. FIXED INCOME PRIMER ABOUT PRUDENTIAL INVESTMENTS Prudential Investments strives to be a leader in a broad range of investments to help you stay on course to the future you envision. Our investment professionals also manage money for major corporations and pension funds around the world, which means you benefit from the same expertise, innovation, and attention to risk demanded by today’s most sophisticated investors. We are part of Prudential Financial, a company America has been bringing its challenges to for 140 years. Bring us yours. FOR MORE INFORMATION, contact your financial professional or visit our website at prudentialfunds.com. Investing involves risk. Some investments have more risk than others. The investment return and principal value will fluctuate, and shares, when sold, may be worth more or less than the original cost, and it is possible to lose money. Fixed income investments are subject to interest rate risk, where their value will decline as interest rates rise. The comments, opinions, and estimates contained herein are based on and/or derived from publicly available information. This outlook, which is for informational purposes only, sets forth our views as of this date. The underlying assumptions and our views are subject to change. Past performance is not a guarantee of future results. © 2016 Prudential Financial, Inc. and its related entities. The Prudential logo and the Rock symbol are service marks of Prudential Financial, Inc. and its related entities, registered in many jurisdictions worldwide. 0218561-00004-00 PI2129 Expiration: 09/30/2018