Certified Financial Management Specialist Practice Exam

What is represented by the term structure of interest rates?

1. The relationship between stock dividends and earnings

2. The relationship between bond yields and maturities

3. The historical performance of commodities

4. The relationship between inflation and interest rates

The correct answer is: The relationship between bond yields and maturities

The term structure of interest rates, often illustrated by the yield curve, specifically represents the relationship between bond yields and their maturities. This relationship indicates how interest rates or yields vary with different time frames until a bond yields its payments. Generally, longer-term bonds tend to offer higher yields compared to short-term bonds due to the increased risk over a more extended period, such as inflation or default. This concept is crucial for investors as it helps them understand how interest rates may change in the future and the potential implications on investment returns. The shape of the yield curve can also give insights into economic expectations, such as growth or recession, based on how different maturities are priced in the market. Understanding this concept is vital for managing interest rate risk and making informed investment decisions in fixed-income securities.