Lecture Overview:

• Term structure and yield curve
• Spot and forward rates
• Theories of term structure
• Applications of term structure

Term Structure and Yield Curve

(1) Left to right: on the same day, interest rates differs with the terms of maturity - term structure of interest rates

(2) From up to down: for the same term of maturity, interest rate changes over time - interest rate risk

• So far we assume $r_f$ is the same for all investment horizons

• Term structure & yield curve are similar

• Term structure in the base case - risk-free rate

  • Yields on zero coupon government bonds
  • Zeros = zero coupon government bond
  • Zero rates = yields of zero coupon government bond = $r_f$ rate at a given maturity