Question

Define and discuss the following:

Term Structure of Interest Rates aka the Yield Curve

(be sure to address the current state of the yield curve and current market expectations based on the current state of the yield curve) (also see the Module Notes for links on this topic)

Answer 1

Term Structure of Interest Rates shows the relationship between interest rates or yields and different terms or maturities.The graphical presentation of the Term Structure of Interest Rates is known as the Yield Curve.It reflects the expectations of market players about the changes in the interest rates and the economic conditions.Generally,Yield increases in line with maturity resulting in an upward sloping yield curve.This is because investors demand higher interest rates for long duration investments as a compensation for holding the money in investments for long duration.

Term structure of Interest Rates and the direction of Yield Curve can be used to assess the state of the credit market.A flattening of the Yield Curve is an indicator of a fall in the long term rates when compared to short term rates and this could have implications for a recession.When the short term rates start to exceed the long term rates, the outlook for long term credit get weak and the Yield Curve will be inverted and give an indication that a recession is likely to occur.