The Influence of Interest Rates in our Lives

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Even though most of us may not realized it, interest rate actually play an important role in our everyday lives due to its great effect on the buying power. For instances, if the interest rate is higher, people tend to reduce their spending and rather save it in the deposit account due to the large interest that they can gained. However, if the interest rate is lower, they rather spend it than keeping it in the deposit account. The reason for this is because the ups and down of the interest rates have a significant impact on their personal income. Furthermore, since interest rate have a major impact on investment it is important for the investors to keep track on these interest rate’s trend before making any decision. It is important for any people who are dealing with interest rate to understand the term structure of interest rate or also known as a yield curve. It is a plot that reflects the relationship between the maturities and interest rates of a security as well as the different pattern it made at different times. There are three different type of shape that are created by the term structure of interest rate. 1) Normal yield curve – it is an upward slope yield curve in which short-term securities have lower yield than long-term securities. As the name suggested, the shape essentially indicate the normal condition in the market where investors believe that there will be no significant changes in the economy such as that the economy will develop at a normal rate. It is actually a normal expectation of the market to offer higher yield to long-term security as compensation because they hold more risk than the short-term security. 2) Inverted Yield Curve – It is a yield curve in which long-term securities have lower yield than ... ... middle of paper ... ...at choose long-term securities. This is due to their business nature that require long-term securities such as companies that involves in project that have long development period. Hence, the yield curve is generally upward sloping. 3. Liquidity premium theory – It is a theory that suggested that the yield of securities in one mature have influence on the yield of another securities. The investors are willing to invest in long-term securities as long as they are provided liquidity premium as compensation due to their long exposure to the long-term risk. As a result of this compensation, the investors are more motivated to in long-term securities. Hence, creating an upward sloping yield curve. There are many factors that can affect the yield curve which is usually according to the economy’s situation. Below are some of the factors that can affect the yield curve.
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