By Miklesh Yadav

Meaning of Term structure of

Interest rate
 The term structure of interest rates – known as the yield
curve – is the relationship between interest rates or
bond yields that differ in their length of time to
maturity. The term structure reflects investor
expectations about future changes in interest rates and
their assessment of monetary policy conditions. The
term structure of interest rates is constructed by
graphing the YTM and respective maturity dates of
benchmark fixed-income securities. Because U.S.
Treasuries are considered risk-free, their yields are often
used as the benchmark.
 The term structure of interest rates is graphed as
though each coupon payment of a noncallable fixed-
income security were a zero-coupon bond that matured
on the coupon payment date. If the normal yield curve
changes shapes, it can be a signal to investors that it’s
time to update their economic outlook.
 Normal Yield Curve
 A normal yield curve forms during normal market
conditions, when investors believe there won’t be any
significant changes to the economy (e.g., interest rates) and
the economy will continue to grow at a normal rate. During
these conditions, investors expect higher yields for bonds
with long-term maturities than those with short-term
maturities.
 This is a normal expectation since short-term instruments
generally carry less risk. The further out a bond’s maturity,
the more time and uncertainty investors face before being
paid back the principal. As current interest rates increase, a
bond’s price will decrease and its yield will increase.
 Flat Yield Curve
 A flat yield curve indicates that the market is sending
mixed signals to investors, who are interpreting interest
rate movements in various ways. In these situations, it’s
hard for the market to determine whether interest rates will
move significantly in either direction. A flat yield curve
generally happens when the market is making a transition
between normal and inverted curves.
 When the yield curve is flat, you can maximize your
risk/return tradeoff by choosing fixed-income securities
with the least risk, or highest credit quality.
 Yield to Maturity (YTM)
 YTM is the total return which is derived from holding it
till maturity. Yield to maturity is considered a long-term
bond yield, but is expressed as an annual rate. In other
words, it is the internal rate of return (IRR) of an
investment in a bond if the investor holds the bond until
maturity and if all payments are made as scheduled.
 In other words, it factors in the time value of money,
whereas a simple current yield calculation does not. As
such, it is often considered a more thorough means of
calculating the return from a bond.
 Formula of YTM
.
Example
We defined yield to maturity as the rate which discounts the
bond's future cash flows (coupons and par value) such that
their present value equals the bond's market price. Company
D's bond has a par value of $1,000; semiannual coupon of $40
(=8%/2×$1,000) and price of $950.

We get the following relationship after plugging in the

variables:
$950 = $1000 × 4% × 1 − (1 + r)−10×2 + $1000
r (1 + r)10×2
Thank You
.