Long Term Rate

By: EconomyWatch   Date: 9 September 2010

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The interest rate that is applicable to a loan that is given for ten years or more is known as a long term rate. Long term rates are totally different from short-term interest rates that are applicable to those investments with a maturity period of three years or less. The longer the interest rate, the higher the returns will be.

Short Term Rate vs. Long Term Rate

Usually, long term interest rates are higher than short term interest rates due to higher intensity of risks to which they are exposed. For instance, by investing in long term instruments, investors lose out on anticipated capital gains that may occur in case of a rise in the short term interest rate.

In addition, these investors forego the current purchasing power of their money, with the hope of earning higher returns in the future. As a result, these investors are compensated with a high long term rate.

In case of slight changes in the market interest rates, the prices of long term instruments vary by a greater percentage, compared to the change in prices of short term instruments. Additionally, long term investments also expose investors tofluctuations in the inflation rate. Thus, a high long term rate acts as a risk premium, which provides immunity to an investorfrom factors like inflation and interest rate risk.

How Are Long Term Rates Determined?

Long-term interest rates are mainly determined by the market forces of demand and supply. For example, if people anticipate a high inflation rate, then the long term rate will be on a higher side. When there is a boom in the economy, the long term rates are usually tightened.

An increase in the long term rate eventually heightens the cost of borrowing, which in return assists to regulate inflation.For instance, higher long term interest rates in the US will help to increase demand for the dollar and prevent depreciation.

Long-term maturities are also vulnerable to several economic catastrophes that might marginalize the returns. They also entaila high risk of default. So, it is essential to protect the investor’s money from these risks. By offering a high long-term rate,the issuers of long term maturities can try and offset the burden of such investing risks.


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