Inverted Yield Curve Essay Example | Topics and Well Written Essays - 1500 words

Inverted Yield Curve - Essay ExampleThe value of a bond is dependent on its required light. Whenever the required return on bonds disagrees from the bonds coupon interest rate, the bonds value will differ from its par value. The required return is likely to differ from coupon interest rate because either (1) economic conditions have changed causing a shift in the basic cost of want-term funds, or (2) the flyings risk has changed. Increases in the basic cost of long-term funds or in risk will raise the required return decreases in the cost of funds or in risk will lower the required return (Lawrence J. Gitman). This is the basic principle of interest rates and bond valuation. The higher up principle shows that the bond valuation is dependent mostly on economic conditions and the firms risk taking ability. So when reasons for lower interest on long-term bonds as compared to short-term bonds are analyzed, it reflects the character of economic conditions. In this way, the bond inter est rates work as the barometer of the economic conditions.Normally long term investments are made in the avenues that show steady performances over a period of time and provide the reasonable rate of return. It is seen that whenever stock mart underperforms, investors withdraw money from stocks and usually invest in long-term bonds. This raises the demand for bonds and as a result of demand and supply interactions, the requirement of funds by dint of debts instruments decreases and the result decreases in the interest rates of bonds.