Define the structure of interest rates and list two theories used to explain the structure. Please...

Define the structure of interest rates and list two theories used to explain the structure.

Please respond with at least 150 or more words for me to understand the response fully!!!

Expert Solution

Structure of interest rates:

The term interest rate refers to the relationship between market rate of interest on short term and long term securities. It is the interest rate difference on fixed income securities due to differences in time of maturity. Therefore it is also known as time structure or maturity structure of interest rates which explains the relationship between yields and maturities of the same type of security.

Theories on structure of interest rates-

Market segmentation theory: Assumes that borrowers and lenders live in specific sections of the yield curve based on their need to match assets and liabilities. The theory goes further to assume that these participants do not leave their preferred maturity section. This the yield curve shape is determined by supply and demand at different maturities.

Liquidity preference theory: Investors prefer short term bonds to long term bonds because of the increased uncertainty associated with a longer time horizon. Therefore investors demand a liquidity premium for longer dated bonds. This theory has a natural bias toward a positively sloped yield curve.

jeff jeffy answered 1 year ago

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