Chapter06_-_Fwd_Rates

# Chapter06_-_Fwd_Rates - The Term Structure of Interest...

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The Term Structure of Interest Rates Chapter 6, Appendix A

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Introduction to the Term Structure • In the main body of the text, interest rates are assumed to be the same for all time periods. • In reality, interests rates vary not only through time, but also with time to maturity at a given date. • The relationship between interest rates and maturity date is referred to as the term structure of interest rates.
Example • The spot rate is the rate currently charged for borrowing for a given period. • Consider two bonds: Bond A is a one year bond. Bond B is a two-year bond (same issuer). • Both have face values of 1000. • The one year (spot) interest rate is 8%, and the two year (spot) interest rate 10%.

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Example It is easy to price the bonds based on the given information. 2 ) 10 . 1 ( 1000 45 . 826 08 . 1 1000 93 . 925 = = = = B A PV PV
Term Structure of Interest Rates Spot Interest Rate Time (years)

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## This note was uploaded on 04/01/2012 for the course ACTSC 371 taught by Professor Wood during the Spring '08 term at Waterloo.

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Chapter06_-_Fwd_Rates - The Term Structure of Interest...

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