The Term Structure and Interest Rate Dynamics
Exam Focus
This topic review discusses the theories and implications of the term structure of interest rates. In addition to understanding the relationships between spot rates, forward rates, yield to maturity, and the shape of the yield curve, be sure you become familiar with concepts like the Z spread, the TED spread and the MRR OIS spread. Interpreting the shape of the yield curve in the context of the theories of the term structure of interest rates is always important for the exam.
Also pay close attention to the concept of key rate duration.
Introduction
The financial markets both impact and are controlled by interest rates. Understanding the term structure of interest rates (i.e., the graph of interest rates at different maturities) is one key to understanding the performance of an economy. In this reading, we explain how and why the term structure changes over time.
Spot rates are the annualized market interest rates for a single payment to be received in the future. Generally, we use spot rates for government securities (risk free) to generate the spot rate curve. Spot rates can be interpreted as the yields on zero coupon bonds, and for this reason we sometimes refer to spot rates as zero coupon rates.
A forward rate is an interest rate (agreed to today) for a loan to be made at some future date.
Modules
- Module 23.1Spot And Forward Rates, Part 1Describe relationships among spot rates, forward rates, yield to maturity, expected and realized returns on bonds, and the shape of the yield curve. 路 Describe how zero coupon rates (spot rates) may be obtained from the par curve by bootstrapping.6 min 路 2 LOS
- Module 23.2Spot And Forward Rates, Part 2Describe the assumptions concerning the evolution of spot rates in relation to forward rates implicit in active bond portfolio management. 路 Describe the strategy of rolling down the yield curve.5 min 路 2 LOS
- Module 23.3The Swap Rate CurveExplain the swap rate curve and why and how market participants use it in valuation.2 min 路 1 LOS
- Module 23.4Spread MeasuresCalculate and interpret the swap spread for a given maturity. 路 Describe short term interest rate spreads used to gauge economy wide credit risk and liquidity risk.4 min 路 2 LOS
- Module 23.5Term Structure TheoryExplain traditional theories of the term structure of interest rates and describe the implications of each theory for forward rates and the shape of the yield curve.5 min 路 1 LOS
- Module 23.6Yield Curve Risks And Economic FactorsExplain how a bond鈥檚 exposure to each of the factors driving the yield curve can be measured and how these exposures can be used to manage yield curve risks. 路 Explain the maturity structure of yield volatilities and their effect on price volatility. 路 Explain how key economic factors are used to establish a view on benchmark rates, spreads, and yield curve changes.7 min 路 3 LOS