Theory of the term structure of interest rates
Course:- Corporate Finance
Reference No.:- EM13881425

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Why long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates?


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Term structure can be defined as the exact relationship related to the rate of returns expected of bond and the maturity of that bond (with similar risk) . When expressed in terms of a diagram it is known as the yield curve. In the long term interest rates tend to be higher than that of short term and these effect is often magnified by the investor expectations. It’s often documented that with a lower interest rate prevailing in the market the bond value tends to be lower and vice versa. This means the bond investor is better off with a lower interest rate as the market value of the bond goes up and vice versa. Yield curve assumptions are based on the fact that all the intermediate cash flows accruing from the bonds are invested at a rate which equals to the YTM of that Bond

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