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Factors Determining Term Structure Of Interest Rate

 Term Structure of Interest Rate

Meaning

The term structure of interest rates denotes to the relationship among market rates of interest on short term and long term securities. It is the interest rate contrast on fixed earning securities due to dissimilarities in time of maturity. It is therefore, also phrased as time configuration or maturity configuration of interest rates which gives explanation the association among yields and maturities of the same type of security.

If two securities are indistinguishable in every value apart from maturity, it is probable that they will sell in the market at diverse prices. Usually their prices will vary in the same course. If the short term securities mount in price, the long term securities will also hike in price. People usually hold both short term securities and they adjust their holdings of securities based on the relative yields.

Normally the long term securities is likely to vary more in price than the short term securities, even though their yields do not fluctuate as much.

Factors

  • Risk Preference
  • Long term security prices are responsive to variations in interest rates for the reason that the variations to evasion are more on long term securities as related to short term securities has indistinguishable acquiesce. This would push up short term prices of securities and bring down the yield.

    Therefore the yield curve inclines upward. On the other hand, borrowers desires to borrow for long period for the reason that they will not have to be bothered about rising interest rates or to renovate their loans constantly.

    They are hence, willing to pay more for long term securities as related to short term securities. This will also tend the capitulate curve to incline upward. Therefore, the penchants of both lenders and borrowers tend to low rates on short term securities and high rates on long term securities thus fetching about an upward sloping yield curve.

  • Supply Demand Stipulation
  • When the supply of short term securities drops and that of long term securities hikes, the short term interest rate comes down and the long term interest rate is shifted up. The yield curve is upward inclining and contra. If the demand for securities is large in the short run market and low less in long run interest rates and the yield curve will be downward inclining. The contra supply-demand stipulations will tend to an upward sloping yield curve.

  • Expectations and Uncertainty
  • Other aspects affecting yield curve are expectations and uncertainty. The expectation of the hike in the long run interest rate describes that the short term interest rate remains much below the long term interest rate for any length of time.

    This creates an upward inclination yield curve. Moreover, specified risks and uncertainties and jeopardy may tend to the same consequents. For example, if people expect war, social disturbances, political upheavals, uncertainties, inflationary pressures etc, they will not purchase long term securities other than at a low price or low current yield.

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