Final answer:
The term structure of interest rates details the relationship between nominal rates on default-free, pure discount bonds and their time to maturity, illustrated by the yield curve. Compensations for delayed consumption, inflation adjustments, and risk premiums influence these rates. The correct option is option 5.
Step-by-step explanation:
The term structure of interest rates represents the relationship between nominal rates on default-free, pure discount bonds and time to maturity. This term structure, also known as the yield curve, reflects how the interest rates of bonds differ based on their time to maturity. When investors buy bonds, they expect varying rates of return, which are influenced by components such as compensation for delaying consumption, an adjustment for an inflationary rise in prices, and a risk premium that takes the borrower's riskiness into account.
Specifically, when the market interest rates change, it affects the attractiveness of bonds with fixed coupon rates. For example, if new bonds are issued at a 5% interest rate and market rates drop to 3.5%, existing bonds with a 5% coupon become more attractive, while if the rates increase to 6.5%, they become less desirable. These dynamics play a crucial role in determining a bond's present value, which is the amount a buyer is willing to pay for a bond today. Please mention the correct option in your final answer, which is option 5.