Ch15 - Term Structure of interest rates Chapter 15 Overview...

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Term Structure of interest rates Chapter 15
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The relationship between yield to maturity and maturity. Information on expected future short term rates can be implied from yield curve. The yield curve is a graph that displays the relationship between yield and maturity. Three major theories are proposed to explain the observed yield curve. Overview of Term Structure
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Term structure of interest rate Interest rate is not constant throughout the holding period Term structure of interest rate is the structure of interest rates for discounting cash flows of different maturities
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Expected One-Year Rates in Coming Years Year Interest Rate 0 (today) 8% 1 10% 2 11% 3 11% Expected Interest Rates
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) 1 )...( 1 )( 1 ( 1 2 1 n n r r r PV + + + = PV n = Present Value of $1 in n periods r 1 = One-year rate for period 1 r 2 = One-year rate for period 2 n Pricing of Bonds using Expected Rates
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Time to Maturity Price of Zero* Yield to Maturity 1 $925.93 8.00% 2 841.75 8.995 3 758.33 9.660 4 683.18 9.993 * $1,000 Par value zero Bond Prices using Expected Rates
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Yield curve YTM vs Years to maturity
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Ch15 - Term Structure of interest rates Chapter 15 Overview...

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