Download presentation

Presentation is loading. Please wait.

Published byDamion Barnes Modified over 3 years ago

1
Term Structure of Interest Rates

2
Outline Meaning of Term Structure of Interest Rates Significance of Term Structure of Interest Rates What is Yield Curve? A spot rate and a forward Rate Theories of Term Structure of Interest Rates

3
Why practically homogeneous bonds of different maturities have different interest rates? This question issue is of great significance to both borrowers and lenders. Should a lender invest in short-term bonds and have to worry about the rates at which to reinvest when short-term bond matures? Or should the lender buy long-term bonds and run the risk of an uncertain liquidating value if selling is necessary before maturity? Borrowers are faced with the choice of whether to borrow short-term or long-term. Short-term borrowing runs the risk that refinancing may be at higher rates. Long-term financing runs the risk that a high rate may be locked in. A study of the yield-curve and term-structure of interest rates can help borrowers and lenders in making the right decision.

4
What is a Yield Curve? A graphical depiction of the relationship between the yield on bonds of the same credit quality, but different maturities is known as the yield curve. Term structure of interest rates may be defined as the relation between yield to maturity of zero coupon securities of the same credit quality and maturities of those zero-coupon securities. Yield-to-maturity on zero-coupon securities for different maturities is also the spot rate for that maturity. Therefore, term structure of interest rate may also be defined as the pattern of spot rates for different maturities.

5
How to Construct the Term Structure of Interest Rates? The yield on Treasury securities is a benchmark for determining the yield curve on non-Treasury securities. Consequently, all market participants are interested in the relationship between yield and maturity for Treasury securities.

6
The graphical depiction of the relationship between the yield on Treasury securities for different maturities is known as the yield curve. While a yield curve is typically constructed on the basis of observed yields and maturities, the term structure of interest rates is the relationship between the yield on zero-coupon Treasury securities and their maturities. Therefore, to construct term structure of interest rates, we need the yield on zero-coupon Treasury securities for different maturities.

7
Zero-coupon Treasuries are issued with maturities of six-months and one-year, but there are no zero-coupon Treasury securities with maturity more than one- year.

8
Thus, we cannot construct such term structure solely from market observed yields. Rather, it is essential to construct term structure from theoretical consideration applied to yields of actually traded Treasury debt securities. Such a curve is called “Theoretical Spot Rate Curve” Any noncallable security can be considered as a package of zero-coupon securities

9
Each zero coupon security in the package has a maturity equal to its coupon payment date and, in the case of principal, equal to maturity date The value of the Treasury coupon security should be equal to the value of the package of zero- coupon securities

10
If this equality does not hold, it will be possible to create arbitrage profits. To determine the value of each zero coupon security, it is necessary to know the yield on the zero-coupon Treasury corresponding to that maturity. This yield is called the Spot Rate

11
The graphical depiction of the relationship between the spot rate and maturity is called the spot rate curve. Such a curve is also known as “Theoretical Spot Rate Curve” Remember spot rate is a zero-coupon rate. The theoretical spot rates for Treasury securities represent the appropriate set of interest rates that should be used to value default-free cash flows

Similar presentations

OK

Fixed Income Basics - part 1 Finance 70520, Spring 2002 The Neeley School of Business at TCU ©Steven C. Mann, 2002 Spot Interest rates The zero-coupon.

Fixed Income Basics - part 1 Finance 70520, Spring 2002 The Neeley School of Business at TCU ©Steven C. Mann, 2002 Spot Interest rates The zero-coupon.

© 2018 SlidePlayer.com Inc.

All rights reserved.

To ensure the functioning of the site, we use **cookies**. We share information about your activities on the site with our partners and Google partners: social networks and companies engaged in advertising and web analytics. For more information, see the Privacy Policy and Google Privacy & Terms.
Your consent to our cookies if you continue to use this website.

Ads by Google

Ppt on kingdom monera pictures Ppt on business etiquettes in china Ppt on area of plane figures Ppt on producers consumers and decomposers as forest View ppt on iphone Ppt on power system security Doc convert to ppt online student Ppt on business etiquettes training day Ppt on central administrative tribunal judgements Ppt on weapons of mass destruction song