Term Structure of Interest Rates
Understanding the Term Structure of Interest Rates
Prepared for Fundamentals of Financial Management
Distributed
October 24, 2005
TABLE OF CONTENTS
List of Figures....................... ....................................... .....................iii
List of Abbreviations and Symbols............................. ..........................iv
Summary............................................................................. ...................5
Introduction.......................................... .................................................7
Understanding the Term Structure of Interest Rates ............. ...............8
Term Structure Puzzle................................................................8
The Yield Curve .8 The Expectations Theory 9
Visual Aids..............................................................................10
Conclusions ......... .............................. .............11
LIST OF FIGURES
Figure 1: Expected Yield Curve When Inflation Is Expected to Increase ..4 Figure 2: Expected Yield Curve When Inflation Is Expected to Decrease.. 5
LIST OF ABBREVIATIONS AND SYMBOLS
k* Real Risk-Free Interest Rate
MRP Maturity Risk Premium
IP Inflation Premium
Fed Federal Reserve Board
KRF Quoted risk free interest rate on a treasury bill
FOMC Federal Open Market Committee
SUMMARY
In the article titled "Understanding the Term Structure of Interest Rates," William Poole examines relationship between short and long term interest rates over the past year. His analysis of these interest rates focuses on the fact that as the Fed
Prepared for Fundamentals of Financial Management
Distributed
October 24, 2005
TABLE OF CONTENTS
List of Figures....................... ....................................... .....................iii
List of Abbreviations and Symbols............................. ..........................iv
Summary............................................................................. ...................5
Introduction.......................................... .................................................7
Understanding the Term Structure of Interest Rates ............. ...............8
Term Structure Puzzle................................................................8
The Yield Curve .8 The Expectations Theory 9
Visual Aids..............................................................................10
Conclusions ......... .............................. .............11
LIST OF FIGURES
Figure 1: Expected Yield Curve When Inflation Is Expected to Increase ..4 Figure 2: Expected Yield Curve When Inflation Is Expected to Decrease.. 5
LIST OF ABBREVIATIONS AND SYMBOLS
k* Real Risk-Free Interest Rate
MRP Maturity Risk Premium
IP Inflation Premium
Fed Federal Reserve Board
KRF Quoted risk free interest rate on a treasury bill
FOMC Federal Open Market Committee
SUMMARY
In the article titled "Understanding the Term Structure of Interest Rates," William Poole examines relationship between short and long term interest rates over the past year. His analysis of these interest rates focuses on the fact that as the Fed