The term structure of interest rates is affected by which of the following?
I.Interest rate risk premium
II.Real rate of interest
III.Default risk premium
IV.Inflation premium

Question

Quizplus · Accepted Answer

The term structure of interest rates refers to the relationship between the interest rate and the time to maturity, for bonds that are identical in all aspects except for their maturity date. The factors that affect the term structure of interest rates include the interest rate risk premium, which compensates investors for the risk of changes in interest rates; the real rate of interest, which reflects the underlying supply and demand for loanable funds in the economy; and the inflation premium, which reflects the expected rate of inflation over the life of the bond. The default risk premium, which compensates investors for the risk of default by the issuer, is also a factor that affects the term structure of interest rates. Therefore, choices I, II, and IV are all factors that affect the term structure of interest rates, and the correct answer is D. Choice B is incorrect because it omits the inflation premium, and choice C is incorrect because it includes the default risk premium but omits the real rate of interest. Choice E is incorrect because it includes all four factors, but it is unclear what is meant by "best choice(s)" as all the factors mentioned are relevant.

The Term Structure of Interest Rates Is Affected by Which