Replies

[Your "fundamental point" now is not consistent with your earlier posts.]

Well, now, I beg to differ. Perhaps you should again read my earlier posts

I read them and copied your earlier points verbatum into my post #90 and summarized them (which summary I didn't see you dispute) and copied your "fundamental point" into my post #96 and laid out the comparison of the two. Perhaps if this is a semantics issue, you could be more specific as to what you meant or which words in post #96 I've not properly compared?

Come on, Starwind, you are talking about the yield curve and validly correlating inflation to market interest rates requires matching maturities.

I was not correlating any specific maturities to the graph or interest rates. The juxtaposition of my description of 'duration premium' at the end of post #96 was simply coincidental (it had to go somewhere - perhaps a topic-change note was needed) and not related to the previous point refuting your specific assertions as to what was an 'in-line real rate of return variation around a mean over time' - a discrepancy between your post #91 and the graph you haven't yet addressed.

Are you suggesting the yield curve would be flat if there were (hypothetically) exactly zero inflation and zero risk of inflation over 30 years?

I simply asserted that investors expect and receive a premium for allocating their principal over a longer period of time.

Further, If I were one of your substantial customers and negotiated a $5M zero coupon bond for say, 2 years, at whatever your requested rate, plus I guaranteed you an inflation compensation premium adjusted, say monthly (so you had no risk of inflation loss), then upon agreement to those terms if I said, "Great, now lets just extend the term out 30 years" - you would agree? With no additional premiums charged? You would not charge more for my keeping your principal an additional 28 years?

What other fundamental determining factors are there?

The following are each determined independently and arise for different reasons, inherent to the nature of the loan:

Real risk-free rate
The rate of interest excluding the effect of expected inflation and compensates the investor for the temporary sacrifice of consumption.
Inflation premium
Compensates the investor for inflation and the risk of estimating inlfation wrong.
Duration Premium
Compensates the investor for lost opportunity over time of alternative investments.
Default risk premium
Compensates the investor for risk of the loan not being repaid or repaid on schedule
Liquidity Risk Premium
Compensates the investor for risk of illiquid collateral assets upon repossesion
Price risk premium
Compensates the investor for risk of having to sell originated loans at a discount
Call risk premium
Compensates the investor for risk of cash flow uncertainty and reinvestment risk introduced by a call provision
Structural Risk premium
Compensates the investor for risk associated with differing cash flows driven by movements in interest rates in different ways as new and different types of fixed income securities can encompass anything with an anticipated and measurable cash flow are candidate to be securitized.
An extreme example is the musician David Bowie who securitized his expected royalty payments on his first 25 albums over the next 10 years and received $55 million from investors.