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Short term interest rates are more volatile than long term interest rates, so short term bond prices are more sensitive to interest changes than long term bond prices?
True or False. Explain
"short term interest rates are more volatile than long term interest rates...." --- TRUE
The above statement is true.
Changes in the short term interest rates are often done more frequently to counter inflationary or deflationary situations in the country. They are usually done as a counter measure which is effective in the short term and this is more of a MICRO economic measure. Long Term Interest Rates involve interest rates on securities such as 30 year bonds. With long term bonds, the interest rate tends to reflect the markets long term expectations of inflation. They tend to be less volatile than short term rates.
I hope this would help.
So, you are saying that the short term are affected by inflation where as the long term are not because they will be in the market for longer periods of time. Please explain.
I don't mean that. The changes in short term interest rates are obviously more frequent as they are meant to address the immediate issues, i.e. to control the supply of money in event of inflation or deflation, as the case may be. These changes are governed by the changes in business cycles, such as demand for credit, automotive demand, weather cyclical demands, seasonal variation / changes in demands, etc. These factors and the effect thereof is of short term nature but to counter its effects, the changes in short term interest rates in done. Though these effects are of short term but occur frequently, the change in interest rate too is to be done frequently making it volatile in the short term.
Long term interest rates, follow the MACRO economic cycle and thus tend to be less volatile relatively.
I am sure this would help.