What does the term structure of interest rates represent?

The term structure of interest rates represents the relationship between interest rates and different maturities. This concept is fundamental in finance as it provides insight into how the yields on debt securities, such as bonds, change based on their time to maturity. Typically depicted in a yield curve, the term structure illustrates how interest rates for various maturities can indicate investor expectations about future interest rates, inflation, and economic conditions.

For example, a normal upward-sloping yield curve suggests that longer-term bonds have higher yields compared to shorter-term bonds, reflecting the increased risk and uncertainty over time. In contrast, an inverted yield curve, where short-term rates are higher than long-term rates, can signal expectations of economic downturns. Understanding this relationship helps investors make informed decisions about the risk and return associated with different fixed-income securities.