Graphically depicts the term structure of interest

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Unformatted text preview: ual returns on debts of equal quality and different maturities. Graphically depicts the term structure of interest rates. inverted yield curve A downward-sloping yield curve that indicates generally cheaper long-term borrowing costs than short-term borrowing costs. normal yield curve An upward-sloping yield curve that indicates generally cheaper short-term borrowing costs than long-term borrowing costs. flat yield curve A yield curve that reflects relatively similar borrowing costs for both short- and longerterm loans. Term Structure of Interest Rates For any class of similar-risk securities, the term structure of interest rates relates the interest rate or rate of return to the time to maturity. For convenience we will use Treasury securities as an example, but other classes could include securities that have similar overall quality or risk. The riskless nature of Treasury securities also provides a laboratory in which to develop the term structure. Yield Curves A debt security’s yield to maturity (discussed later in this chapter) represents the annual rate of return earned on a security purchased on a given day and held to maturity. At any point in time, the relationship between the debt’s remaining time to maturity and its yield to maturity is represented by the yield curve. The yield curve shows the yield to maturity for debts of equal quality and different maturities; it is a graphical depiction of the term structure of interest rates. Figure 6.3 shows three yield curves for all U.S. Treasury securities: one at May 22, 1981, a second at September 29, 1989, and a third at March 15, 2002. Note that both the position and the shape of the yield curves change over time. The yield curve of May 22, 1981, indicates that short-term interest rates at that time were above longer-term rates. This curve is described as downward-sloping, reflecting long-term borrowing costs generally cheaper than short-term borrowing costs. Historically, the downward-sloping yield curve, whi...
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