Money,Banking&Finance Essay Example | Topics and Well Written Essays - 1750 words

Money,Banking&Finance - Essay ExampleThe present prices of the mystifys would help in the use of the market rate of interest, or the price that would be paid for the use of the money for a stop consonant of prison term. There exists a functional relationship between the rate of interest and the time of the bonds. The term social organisation of interest rate or the yield bow shows the relationship between the rate of interest and the yields of the bonds with the ground to maturities. The curve is a representation of the variant opportunities that may exist for the arbitrage as well as the expectation of the markets about the interest rates that may prevail in prox. Interest Rates speckle carrying out the analysis of the yield curve it is essential to know the components of the nominal interest rates. This equation shows that the true rate of interest represented by r is the main component of the rate of interest. On the new(prenominal) hand, sigma is the risk agiotage th at is being added to the rate of interest which is open to fluctuations due to various yetts. On the former(a) hand, ? is the representative of the rate of inflation while l is the component that would capture the liquidness. The various financial markets would support bonds and other long term instruments that would be offering a variety of interest or the rates of return (Kettell, 2001, pp. 19-26). The premium is the representation of the consumer behaviour that would depict that the consumers would be unwilling to hold that particular summation class. The following diagram shows the break-up of the various components of the rates of interest. The loans that are provided for the long term cost higher because the premium for liquidity would increase with the increase in the tenure of the bonds. The people would always want to hold liquidity at the present period of time rather than a later period. The opportunity cost of property the money in the hand would be less in the pres ent period as compared to the future period. buffer Curve The yield curve is drawn from the yield to matureness of the bonds. The yield to maturity (YTM) is considered to be the approximate value of the rate of interest for a particular term to maturity of a bond. The various points of the terms to maturity and the corresponding yields to maturity are plotted on a plane and the curve that is fitted along these points is known as the yield curve. The following diagram is an example of a yield curve. In the plane the vertical axis measures the yield of the bonds and the horizontal axis measures the term to maturity of the bond. Figure 1 Yield curve The yield curve thus summa parents yield of the different bonds that are being traded on a particular date. The yields or the different tenors in such cases may be different. The yield of a bond is the unique rate at which the cash flows that is provided by a bond is discounted. Thus even though the accrual of the cash flows are taking pla ce at the different points in time the rate at which it is taking place is the same (Rossi, 2007, pp. 225-241). This rate is known as the yield to maturity of the bonds. In most cases the interest rates are considered to be fixed for the entire tenor. This would give rise to a flat yield curve as shown in the diagram below. Throughout the tenure of the bond the rate of interest that has been offered in case of this yield curve is 3.5%. Figure 2 Flat Yield Curve The