 In this section we are going to talk about the term structure of interest rates. So it has been observed that the financial instruments with the same maturity can have different interest rates. So why there is a difference in the interest rates for the financial instruments if they have the same maturity time period is an interesting thing and we need to understand and for that particular reason we are we want to know that what are the factors that cause this difference in the interest rates. So altogether we can say that there are four factors that can cause differences in the interest rates and among these factors are the default risk, the liquidity, the tax consideration and the fourth one is how much time is left to the maturity. So we are going to discuss these four factors one by one in detail in the subsequent sections. So the first thing I am going to discuss with you is how the default, what is default risk and how it affects the value of the interest rate. So default risk is defined as the probability that is associated with a financial instrument. In our case we are talking about bonds, the demand in the supply of bonds, the prices of bonds and the interest rates or the yields on bonds. So we will be talking about bonds specifically and the default risk that are linked up with the bonds. So if there is the issuer of a bond who is unable or unwilling to give the promised discount rate or the interest to the investors or they are unable or they are not ready to pay the investors the face value that they have promised. So if that is married in terms of the probability that whether they will be unable to pay this promised money to the investor or they can surely pay the promised money to the investor that particular phenomenon is defined as the default risk. So if we categorize the bonds as the bonds issued by the private sector or the corporations and the bonds that are issued by the government sector or the central bank of a country we can say that the default risk associated with the corporate bonds is always higher as compared to the default risk which is linked up with the government bonds or the bonds that are issued by the government sector or the bonds that are issued by the central bank of a country. For example like in our case it will be the state banks bonds or any financial instruments that are issued by the central bank. So when we look at the triary bonds or the bonds that are issued by the government sector we say that the default risk is relatively low or almost negligible because rarely it happens that a government fails to repay to its investors the promised amount of money whereas if we look at the corporate bonds or the bonds that are issued by the corporate sector often this can happen that they are unable to repay or pay off the promised interest rate or they are unable to sometimes the companies they just collapse and they go bankrupt and they are unable to give back the promised amount of money or the face value at which they have taken the money from the investors. So this particular phenomenon can be explained in terms of the premium which we have to pay against the default risk. So right now on the screen you can see there are two diagrams on the left side you can see panel A in which we can see the demand and the supply curves for the corporate bond market and on the right side we can see the triary bonds market the demand and supply curves have been drawn. So suppose initially corporate bond market may the blue demand curve and the blue supply curve are showing the equilibrium price level which can be observed as P1C. So there is this equilibrium in the corporate bond market corresponding to P1C it means corporate bond market has the value of corporate bonds, equilibrium price that is P1C whereas if we look at the initial demand curve of the triary bonds this is the panel B in which we have taken the demand and supply of the default free US triary bond market so blue curve is our demand, demand curve D1 blue curve is our initial demand curve and our blue supply curve that is the initial triary bonds supply is showing so the intersection of the two curves show the equilibrium price in the default free US triary bond market will be P1T that means the triary bonds are C stands for the corporate bonds. So suppose there is some mismanagement news in us in this particular corporation whose corporate bonds we have taken here so there is some panic among the investors everybody got to know that there is something wrong with this company so they will not be able to repay us the promised amount of the interest rate which they have agreed when they issued the bonds so as a result what will happen due to this panic, due to this problem or due to the increase in the default risk what happened is that your demand curve D1C has shifted backward so the shifted demand curve is representing from the brown curve from the brown line and as a result of this backward shift in the demand why the demand curve I have told you that the default risk has increased so what we have got is the equilibrium price that has fallen to the corporate bond P1C to P2C and due to this panic what people did they started demanding more of the default free US triary bonds and its demand increased and as a result when the demand increased for the triary bonds then its equilibrium price has gone from P1T to P1T and now we can see that due to the increase in the default risk now the difference in the price is that initially we assumed that the price was equal to the price of bills, of the triary bonds and of the corporate bonds but when this panic came due to the increase in the default risk price of the corporate bonds has fallen and the price of the triary bond has increased so the additional money people are ready to pay for the triary bonds this is termed as the risk premium which they are ready to pay which means that if the investor prefers to not buy the corporate bond with the increase in the default risk then the interest rate and the face value on the maturity which has been promised to you by the company or government to issue any bonds should give you the same value so that you don't have any loss so we can see that the investors will have to pay the risk premium in the case of increase in the default risk associated with the corporate bonds and in this context there is an important thing which we need to understand and that is that in this particular situation the price has fallen due to the corporate bond so if the corporate bonds have to increase their sales then they have to promise that they will offer a higher interest rate that we are getting money from the government we will have to show you the higher value of the corporate bonds only then people or investors will be ready to invest in corporate bonds