Explain The Term Structure Of Interest Rates Essay

Explain The Term Structure Of Interest rank - Essay ExampleInterest date data for bonds with different maturities date is published frequently and investors bay window use it to de confinesine the call construction of concern calculates. Some of the most popular fireingness rate data sources are the Wall Street Journal, Federal Reserve Bulletin and websites like Bloomberg and CNN. The term structure suffer be verified at any point in age by victimisation published data from renowned sources. Yield curves are drawn using this published data on care rate. There are short term and long term stake rates. Since long term interest rates have an element of adulthood date risk premium (MRP), they are usually high than short term rates. When researching on the term structure of interest rates, it is important to have knowledge of ordinarily used terms like the Yield to Maturity (YTM), which is defined as the anticipate rate of check on a bond held till maturity (Brigham and Ehrhardt, 2010). Another concept which is discussed with YTM is that of the zero coupon bonds (or dissolve bonds). A zero coupon bond is a financial asset which at the date of maturity T, pays its holder a lump sum amount, with no coupon payments before the date of maturity (hence the title zero-coupon). The YTM at time t of a discount bond with maturity T is the constant and perpetually colonialed rate of rate of return at which the price of the bond accrues from time t to time T and pays one currency unit to the holder at time T. The YTM is likewise referred to as the fill in rate and the notation R (t, T) is used for it. Spot rates are short term interest rates and the term structure of interest rates depicts the relationship between spot rates and their dates of maturity (Gibson, Lhabitant and Talay, 2010). Interest rates are not only used in discounting and pricing for zero-coupon bonds but also other financial derivatives because their prices are sensitive to interest r ates. If we go beyond the scope of an individual investor, we can see that interest rates are also important to corporations. This is because when corporations are doing project appraisals, they use interest rate for computing the net present value and the discounted payback period for a project. The cost of enceinte which is of prime importance to corporations also depends upon interest rates (Benninga and Wiener, 1998). It pass on be useful to specify the fount of interest rate before discussing investment decisions and discounting. There are two main types of interest rates simple interest rate and compound interest rate. Simple rate of interest is interest on a lump sum principal amount and it does not itself earn interest. Quite contrary to this, is the compound rate of interest which itself earns interest. Investment decisions and discounting are all predominantly based on compound interest rates (Kelly and Tracy, 2010) Long term interest rates are an average of short term interest rates. The relationship between short and long term interest rates involves expectations. For example, if it is expected that short term interest rates will fall then the long term interest rates will fall below the current short term rate. The contrary situation is also valid if it is expected that short term interest rates will increase then the long term interest rates will rise above the current short term rate. These two situations are thinkable only because long term rates are derived from short term rates. It is a general detection that long rates are greater than short rates and this is termed as the