0

I've been trying to educate myself on some financial terms and I've gotten into a point where I'm a little confused.

Reading Understanding Term Spreads or Interest Rate Spreads I guess to understand that in simple terms a spread is comparing interest rates on bonds of equal value that mature at different times.

My confusion is in the last paragraph of the article. If the term spread is positive, the long-term rates are higher than the short-term rates at that point in time and the spread is said to be normal. Whereas a negative term spread indicates. When would an entity ever issue a longer termed bond at a lower interest rate than the same bond at a shorter term. Why would any investor lock their money in for longer for a smaller return?

I understand that total amount gained would/could be greater on longer term bond just because it is locked away for longer, but once the shorter bond matures could that investment not be reinvested somewhere else for the delta time between the two bonds resulting in a much greater return?

Is interest rate forecasting accurate enough to warrant an inverted yield curve if they predict that interest rates will take a nose dive? (This is the only way I can see a company issuing an inverted yield curve)

How/why would an entity offer bonds with an inverted yield curve?

Since I'm very green to investing I'm sure that there is something I'm missing.

Edit: After a little research: Can an inverted yield cure only happen after a bond is issued, when investors are trading the various bonds?

1

When would an entity ever issue a longer termed bond at a lower interest rate than the same bond at a shorter term.

It's not that entities are issuing bonds at lower rates, but that their value has risen and their yield is now lower. In other words, spreads aren't driven off on new bond issuances, but the market price of existing bond issuances. So I'll reframe your question from the market's perspective.

When would an entity the market ever issue buy a longer termed bond at a lower interest rate than the same bond at a shorter term.

When the market believes that short-term interest rates are high, but that over the long run, they will decline to a lower level.

Suppose I can buy a 2 year bond today at a 4% yield, and I think that in two years that interest rates will decline significantly. Yes I can make a quick 4% on a two-year bond, but then I'm going to have to invest that money in new bonds at significantly lower rates. Alternatively, I can lock in a rate for 10 years and then don't have to worry about what rates will be like in two years.

Now flipping it back to issuers - issuers would love to issue bonds at low rates (since it means less interest for them), but if they think that they can refinance a 2-year bond at a much lower rate, they may prefer to do that.

So from either side it's all driven by market expectations of interest rates and supply/demand of debt.

| improve this answer | |

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.