Even though most of us don't realize it, interest rates actually play an important role in our daily lives by because of their great effect on purchasing power. For example, if the interest rate is higher, people tend to reduce their spending and instead keep it in their deposit account because of the significant interest they can earn. However, if the interest rate is lower, they prefer to spend it rather than keep it in their deposit account. The reason is that increases and decreases in interest rates have a significant impact on their personal income. Additionally, since interest rates have a major impact on investing, it is important for investors to monitor these interest rates before making a decision. It is important for anyone dealing with interest rates to understand the term structure of interest rates. or also known as the yield curve. This is a chart that reflects the relationship between maturities and interest rates of a security as well as the different trends it has created at different times. There are three different types of shapes created by the term structure of the interest rate. 1) Normal yield curve – this is an upward-sloping yield curve in which short-term securities have a lower yield than long-term securities. As the name suggests, the form basically indicates the normal market condition in which investors believe that there will be no significant changes in the economy, for example that the economy will grow at a normal rate. In fact, the market normally expects to offer a higher return on long-term securities as compensation because they carry more risk than short-term securities. 2) Inverted Yield Curve – This is 'a yield curve in which long-term securities have lower yields than...... middle of paper ...... choosing long-term securities. This is due to their commercial nature which requires long-term securities, such as companies involved in projects having a long development period. Therefore, the yield curve is generally upward sloping.3. Liquidity Premium Theory – This is a theory that suggests that the performance of securities at one maturity has an influence on the performance of another security. Investors are willing to invest in long-term securities provided they receive a liquidity premium as compensation for their long exposure to long-term risk. Thanks to this compensation, investors are more motivated to invest in long-term securities. Hence, creating an upward sloping yield curve. Many factors can affect the yield curve, which generally depend on the state of the economy. Below are some of the factors that can affect the yield curve..