B.01.BKM 15/Hull 4

  1. Spot rate
    Interest rate that applies from 0 to t = ytm of zero coupon bd
  2. Short rate
    Interest rate that will apply during future time interval
  3. Forward rate
    Future expected short rate
  4. Forward Rate Agreement (FRA)
    • Over the counter agreement to xchg specified rate applied to specified principal during specified future interval
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  5. 3 theories to explain shape of yield curve
    • Expectations hypothesis: forward = exp short rate
    • Liquidity preference: ask for liq prem. If ST investors dominate, rising yield curve
    • Segmentation theory: short/medium/long term rates independent. Determined by supply & demand
  6. Interpreting Term Structure
    • investors believe expectation theory is correct
    • doesn't mean other theories not partially correct
    • have to remove their effect when calculating forward
Card Set
B.01.BKM 15/Hull 4
Term Structure of Interest Rates