Question

1)

Investors usually knows that short term US treasury bills pay the lowest yields, then short-term corporate paper pays more, then treasury bonds pays more, then long-term corporate bonds pay the most.

Using technical terminology explain Why is that must be true ?

2)

Market interest rates dropped to the lowest levels seen since the 1950s at the beginning of the great recession.

Using technical terminology how this can be explained? What happened to the demand for financing and what would have been happening with inflation?

Answer 1

1) US treasury bills are short term investment instruments with a maturity of one year or less. It is backed by the U.S. Treasury Department. Treasury bills have maturities ranging from a few days up to a maximum of 52 weeks. The most common maturities are 4, 8, 13, 26, and 52 W. The longer the maturity, the better will be the rate of interest. Treasury bills are considered as a safe investment since the U.S. government backs them.
Short-term corporate papers are unsecured in nature but are relatively safe, the maturities ranges from 90 days to nine months. The reason why short tern corporate paper offer better yield is because these are unsecured and the companies/corporates use this to finance short term requirement.
Treasury bonds are long term fixed rate debt securities, which have a maturity range between 10 and 30 years. These are backed by the government so they are secure. These provide more yield compared to short term corporate bonds because it has a very long maturity whereas short term corporate bonds have a maturity of maximum 9 months.
A corporate bond is an also a debt security but it is issued by corporates, the company issues these to generate long term capital and in return, the investor gets a fixed or variable interest rate. These offer better yield because these are corporate instruments, the chances of a corporate defaulting is always more than that of the government..
2) During any financial crisis, the interest rates are the first to get tampered. To know why this happens, we need to understand what factors affect the interest rates. Market interest rates are determined mainly by the supply and demand for loans.In a recession, the demand for financial loans dropped drastically. This was majorly because the businesses did not have hopes in the market and felt that the conditions are not suitable for business. So when businesses do not take loans, the financial institutions will reduce their interest rates, when the borrowing rate is down, then the deposit rates also drop equally.
During inflation, the rates go down this is because there is an inverse relationship. Between interest rates and the rate of inflation. So when interest rates are down, inflation increases. And when interest rates are up, the inflation decreases.

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