Firstly, this report will depict briefly what a bond is in general and how to evaluate its advantages and inconveniences for potential investors. Then it aims at to explain when and why the yield on long-term bonds often exceeds the yield on short-term bonds. The explanation will mainly be based on the three primary theories: the expectations hypothesis, the liquidity premium / preferred habitat theories and the market segmentation theory.
Table of Contents
- Abstract
- What is a bond?
- Three theories to explain interest rates
- The pure expectation theory
- Market segmentation theory
- Premium liquidity theory
- Conclusion
- References
- Bibliography
Objectives and Key Themes
This report aims to explain why the yield on long-term bonds often exceeds the yield on short-term bonds and why this is not always the case. It will achieve this by examining the three primary theories of the term structure of interest rates: the expectations hypothesis, the liquidity premium theory, and the market segmentation theory. The report will also briefly define bonds and their key characteristics.
- The relationship between bond yields and maturities
- The various theories of interest rates
- The different shapes of the yield curve
- The role of risk aversion in investor decision making
- The factors influencing the term structure of interest rates
Chapter Summaries
- The report begins by defining bonds and explaining the significance of the yield curve in understanding their value. It then introduces the three main theories of interest rates, providing background information on each. The first theory, the pure expectations theory, proposes that the shape of the yield curve reflects market consensus on future interest rates. The second theory, the market segmentation theory, postulates that the bond market is comprised of distinct segments based on maturity, with investors preferring specific maturity segments. Finally, the liquidity premium theory combines elements of the first two theories by suggesting that long-term bonds carry a positive liquidity premium to compensate investors for their risk aversion.
- The chapter on "What is a bond?" provides a basic explanation of bonds as a financial instrument representing debt, outlining the key features of bonds and their different maturities (short-term, medium-term, and long-term).
- The chapter on "Three theories to explain interest rates" examines the three major theories: the pure expectations theory, the market segmentation theory, and the liquidity premium theory. Each theory is explained in detail, outlining its key assumptions, how it explains the different shapes of the yield curve, and its strengths and weaknesses.
Keywords
The main keywords and focus topics of this report include bond yield, term structure of interest rates, yield curve, expectations theory, market segmentation theory, liquidity premium theory, risk aversion, bond maturity, and investment decision-making.
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- Diana Ruthenberg (Autor), 2004, The term structure of interests rates, Múnich, GRIN Verlag, https://www.grin.com/document/53766
