Simply stated longer maturities tend to have higher

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Unformatted text preview: erences of lenders and borrowers cause the yield curve to tend to be upward-sloping. Simply stated, longer maturities tend to have higher interest rates than shorter maturities. Market Segmentation Theory The market segmentation theory suggests that the market for loans is segmented on the basis of maturity and that the supply of and demand for loans within each segment determine its prevailing interest rate. In other words, the equilibrium between suppliers and demanders of shortterm funds, such as seasonal business loans, would determine prevailing short- 6. It is interesting to note (in Figure 6.3) that the expectations reflected by the September 29, 1989, yield curve were not fully borne out by actual events. By March 2002, interest rates had fallen for all maturities, and the yield curve at that time had shifted downward and become upward-sloping, reflecting an expectation of increasing future interest rates and inflation rates. 7. Later in this chapter we demonstrate that debt instruments with longer maturities are more sensitive to changing market interest rates. For a given change in market rates, the price or value of longer-term debts will be more significantly changed (up or down) than the price or value of debts with shorter maturities. CHAPTER 6 Hint An upward-sloping yield curve will result if the supply outstrips the demand for short-term loans, thereby resulting in relatively low shortterm rates at a time when longterm rates are high because the demand for long-term loans is far above their supply. Interest Rates and Bond Valuation 271 term interest rates, and the equilibrium between suppliers and demanders of long-term funds, such as real estate loans, would determine prevailing long-term interest rates. The slope of the yield curve would be determined by the general relationship between the prevailing rates in each market segment. Simply stated, low rates in the short-term segment and high rates in the long-term segment cause the yield curve to be upward-s...
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