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In its simplest form, the term premium is the excess yield that investors require to commit to holding a long-term bond instead of a series of shorter-term bonds.

While the concept is not very difficult to understand, measuring the term premium can be quite confounding. This is because the key component of the term premium is investor expectations about the future course of short-term rates over the lifetime of the long bond. Therefore, term premium is actually the compensation that investors require for bearing the risk that short-term treasury yields do not evolve as they expected.

It is important to note however, that while we usually think of the term premium as being positive–that financial market participants require extra yield to induce them to hold a bond for a longer period of time–there is nothing in the definition of the term premium that requires it to be so.

Term premium, along with expected inflation, and the future path of short-term rates is one of the three components that determine the yield of bonds. not surprisingly, all three components are helping to keep longer-term interest rates low at present. term premiums have recently been zero or even slightly negative.


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