The term structure of interest rate describes the relationship between interest rates and the term to maturity and the differences between short term and long term interest rates.
The relationship between short and long interest rates is important to corporate managers because:
1. They must decide whether to buy long term or short term bonds and whether to borrow by issuing long-term or short-term bonds.
2. It enables them to understand how long term and short term rates are related and what causes the shift in their relative positions.
Several theories had been advanced to explain the nature of yield curve – These are:
1. Liquidity preference theory
2. Expectation theory
3. Market segmentation theory