Question

Explain the following statement: “Short-term interest rates are more volatile than long-term rates. The prices of long-term bonds are more volatile than those of shorter-term bonds.”

Answer 1

Short term interest rates are more volatile than long term interest rates because changes can be made within short term interest rates in order to handle the situation like sudden increase in the price of goods and services and also with sudden decrease in the price of goods and services. In long term interest rates they have long bonds for security purposes and it mainly effect the sudden increase in the price of goods and services.

The prices of long term bonds are more volatile than shorter term bonds because in long term interest rates system bonds are made and they are long enough which leads to increase in the risks.The bond period is high in long term interest rates and in order to handle the fluctuations interest rates are high with in long term interest.

Long term interest rate and short term interest rate can be explained with an example :

Short term interest : Suppose one day your best friend ask for 25000 rupees and he promises you that he will return the money by the end of the week.This is a kind of short term loan where you are the lender and borrower is your friend. If you are collecting interest to this short term loan then it is known as short term interest rate.

Long term interest : suppose one day your best friend ask for 25000 rupees and he promises you that he will return the money only after two years.This is a kind long term loan where you are the lender and borrower is your friend. The interest collected to this long term loan is known as long term interest rate.