In general, the paper 'Financial Instruments, Term Structure and Yield Curve" is a perfect example of finance and accounting coursework. Interest rates and time to maturity are some of the most important factors that a person has to take into consideration when making an investment or borrowing decision. Geiger (2011) attributes this to the fact that the duration it takes for a financial instrument such as a bond to mature determines the amount of interest that the person has to pay at the maturity of the financial instrument. Interest, in this case, refers to the price of borrowing money for the use of its purchasing power while term to maturity denotes the remaining life of a debt instrument (Choudhry, 2011).
That is, the time duration it takes until the last payment of a debt is made. Whenever the interest rates are plotted against the term to maturity, this results in the development of a curve known as the yield curve. In other words, a yield curve is a curve portraying the relationship between interest rates of a given security and term to maturity.
Using the term structure of interest theories, this essay illustrates the relationship between interest rates of different financial instruments and term to maturity in light of their marketability. Yield Curve A yield curve is a very important tool that investors and borrowers can use to make a well-informed decision about their investment or borrowing decisions. As explained earlier, a yield curve is an expression of the relationship between the cost of borrowing or interest and the time to maturity of a particular financial instrument. Yield curves take different shapes depending on the financial instrument and the relationship between interest rates on that security and time to maturity (Mishkin & Eakins, 2012).
The shapes can be normal, steep, flat or inverted yield curves. A normal curve results when the yield of a particular security increases as the time to maturity increases (Elton & Gruber, 2009). In other words, the slope of the yield curve is positive in which case an investor expects the economy to perform well in the future and that inflation will also rise in the future rather than fall. A flat yield curve results when long-term yields are below short-term yields (Choudhry, 2011).
Flat yield curves usually result in situations where lenders are more interested in long-term debts contracts than short-term debt contracts. An inverted yield curve, however, occurs when interest rates for a given security are lower for each payment period so as to allow lenders to attract long-term borrowing (Elton & Gruber, 2009).
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Cecchetti, G. S. (2008). Money, banking, and financial markets. New York: McGraw‐ Hill.
Choudhry, M. (2011). Analysing and interpreting the yield curve. Upper Saddle River: John Wiley & Sons.
Elton, E. J., & Gruber M. J. (2009). Modern portfolio theory and investment analysis, 5th edition. West Sussex: John Wiley & Sons.
Geiger, F. (2011). The yield curve and financial risk premia: Implications for monetary policy. London: Springer Science & Business Media.
Mishkin, S. F., & Eakins, G. S. (2012). Financial markets and institutions, 7th edition. Pearson Prentice Hall.