Question

What does the term structure of interest rates indicate? Why do investment professionals monitor it so closely?

Answer 1

The Term structure of interest rates is also known as a Yield curve, this curve basically shows the connection between Interest rates or Security(Bond) yields and different terms or maturities, these rates plays an important role in an economy. The term structure reflects desires of market participants about future changes in interest rates and their assessment of investment conditions.

Generally, when the term structure of interest rates curve is positive, it indicates that investors desires a higher rate of return for taking the increased risk of lending their money for a longer time period.

Many professionals believe that a steep positive curve means that investors expect strong future economic growth with higher future inflation (and thus higher interest rates), and that a sharply inverted curve means that investors anticipate slow economic growth with lower future inflation (and thus lower interest rates). A flat curve generally indicates that investors are unsure about future economic growth and inflation. This is the reason investment professionals monitor it so closely.