The time value of money is arguably the most important principle of finance. Interest rates are a convenient way to measure and state the time value of money. Furthermore, understanding interest rates is essential for understanding money market and fixed-income securities. In this chapter, we covered a number of topics relating to interest rates, including:

1. Important short-term money market rates include the prime rate, the Federal funds rate, and the Federal Reserve's discount rate. The prime rate is a bellwether of bank lending to business, while the Federal funds rate and the Federal Reserve's discount rate are indicators of the availability of money and credit within the banking system.
2. A Treasury yield curve graphs the relationship between yields on U.S. Treasury securities and their maturities. The Treasury yield curve is fundamental to bond market analysis because it represents the interest rates that financial markets are charging to the world's largest debtor with the world's highest credit rating—the U.S. government.
3. The term structure of interest rates is the fundamental relationship between time to maturity and interest rates for default-free, pure discount instruments such as U.S. Treasury STRIPS.
4. A number of different theories—including the expectations theory, the maturity preference theory, and the market segmentation theory—have been proposed to explain why the term structure of interest rates and yield curves may be upward sloping at one point in time and then downward sloping or flat at another time. In a modern view of the term structure, yields on default-free, pure discount bonds are determined by the real rate of interest, expectations of future inflation, and an interest rate risk premium.
5. Interest rates have five basic components: the real rate, an inflation premium, an interest rate risk premium, a liquidity premium, and a default premium. U.S. Treasury securities are free of default risk and are very liquid, so the last two components are absent from such instruments. For other issues, however, these components are very important. Tax status is also an important determinant.