Preview

Term Structure of Interest Rate

Good Essays
Open Document
Open Document
5067 Words
Grammar
Grammar
Plagiarism
Plagiarism
Writing
Writing
Score
Score
Term Structure of Interest Rate
Term Structure of Interest Rate. Candidate number 25909

Section 2
In this section, I will introduce some essential components about term structure, explain the IS/LM model to reveal the relation between term structure and GDP growth and lastly bring in some empirical evidence to support this relation.

2.1 Some basic terminologies and equations

Bond, being one of the most popular financial products, is one example of firm’s and nation’s lending and borrowing. There are two ways a bond delivers its return. (Please note that when comparing the yield of different bonds, only the terms to maturity vary. All other characteristics are identical.)

The first way is to offer a coupon every period and the principle along with a coupon when the bond matures. Face value is denoted by D. coupon payment by C, maturity by N, price by P, yield by Y. The log of each variable is expressed in lower case. Now, we can calculate the price of bond with a yearly coupon payment by [1]:

And if we assume the payment is in continuous stream, the time difference is dt and the coupon payment is there for Cdt. Then the price equation is [1]:

The second way is to only offer its face value on a specified date, no coupon payment before it matures. This type is called zero-coupon bond and the price of it is just [2]:

Again, if we rearrange and show it in a continuous form [2]: ; (Please note that in the above three equations, Professor John H. Cochrane considers Y(N)
1 / 19

Term Structure of Interest Rate. Candidate number 25909

and y(N) as one plus the yield to maturity (YTM), namely Y(N)=1+YTM and log(Y(N))=log(1+YTM)=y(N).)

In a more widely expressed form, the yield of a zero-coupon bond, for purchasing a bond at its current price and holding it till maturity at time N to receive £1, is the following:

Since

Another vital rate for the term structure is the forward rate, maturity and N’ is the years of holding. For instance,

, where N is the year of means

You May Also Find These Documents Helpful

  • Satisfactory Essays

    M&a Practice Question

    • 901 Words
    • 4 Pages

    3. Suppose the U.S. Treasury offers to sell you a bond for $747.25. No payments will be made until the bond matures 5 years from now, at which time it will be redeemed for $1,000. What interest rate would you earn if you bought this bond at the offer price?…

    • 901 Words
    • 4 Pages
    Satisfactory Essays
  • Good Essays

    4. A zero coupon bond is a bond that pays no interest and is offered (and initially sells) at par. These bonds provide compensation to investors in the form of capital appreciation.…

    • 11041 Words
    • 44 Pages
    Good Essays
  • Good Essays

     What is the straight-line method of amortizing discount and premium on bonds payable? Provide an explanation of the process.…

    • 875 Words
    • 4 Pages
    Good Essays
  • Satisfactory Essays

    ADelpilar W4 Problem Set

    • 709 Words
    • 3 Pages

    Bond-6. A given bond has five years left to maturity. Interest is paid annually and the annual coupon rate is 9%. The par value of the bond is $1,000. The bond currently sells for $1,000. What is the yield to maturity?…

    • 709 Words
    • 3 Pages
    Satisfactory Essays
  • Better Essays

    Investment Fundamentals

    • 1823 Words
    • 8 Pages

    This paper will calculate the returns on five investments to illustrate how they work. It will also discuss the different types of investments a person can make, along with the differences between the various types of bonds. Furthermore it will state what bond ratings indicate, and the two major agencies that are in charge of assigning these ratings…

    • 1823 Words
    • 8 Pages
    Better Essays
  • Satisfactory Essays

    Managerial Finance

    • 1271 Words
    • 6 Pages

    5. A bond has a $1,000 par value, makes annual interest payments of $100, has 5 years to maturity, cannot be called, and is not expected to default. The bond should sell at a premium if interest rates are below 10% and at a discount if interest rates are greater than 10%.…

    • 1271 Words
    • 6 Pages
    Satisfactory Essays
  • Good Essays

    Final 1

    • 1197 Words
    • 5 Pages

    5. Which of the following statements is correct concerning the term structure of interest rates?…

    • 1197 Words
    • 5 Pages
    Good Essays
  • Better Essays

    Acc/291 Week 1 Reflection

    • 790 Words
    • 4 Pages

    Issuance of bonds is a certificate of debt that is issued by a government or corporation in order to raise money; the issuer is required to pay a fixed sum annually until maturity and then a fixed sum to repay the principal. Bonds may be issued at face value, below face value (at a discount), or above face value (at a premium). When recording the Issuance of Bonds on the necessary journal entries these three different types of bond change the way the bond is recorded. Periodic interest is usually based on a period of time, i.e. daily, monthly, quarterly, semiannually or annually. Periodic interest is recorded based on the time period of the bond. Amortization is paying off debt in regular installments over a period of time. Due to the fact that bonds sold at a discount or a premium cost the company money, these costs must be paid back over the period of the bond to ensure a balance. There are two methods of amortizing bond premiums and discounts: 1) effective-interest method and 2) straight line…

    • 790 Words
    • 4 Pages
    Better Essays
  • Satisfactory Essays

    Though coupon-bearing bonds have more reinvestment risk than zero coupons, zero coupon bonds are more volatile and present bigger interest rate (price) risk. Zero coupon bonds do not pay holders interest payments as typical bonds do, and zero coupons pay coupons over the life of the maturity but only pay face value of the bond as of the maturity date. Overall, zero coupon bonds will gain on the difference between what was paid for the bond versus what will be received at maturity and traditional bonds will gain from the expected distribution of…

    • 94 Words
    • 1 Page
    Satisfactory Essays
  • Satisfactory Essays

    Cougars Case

    • 741 Words
    • 3 Pages

    If a bond trades at a discount, its yield to maturity will exceed its coupon rate. Zero coupon bonds always sells at a discount. The sensitivity of a bond’s price to changes in interest rates is measured by the bond’s duration. A bond with high durations,its price is highly sensitive to interest rate changes. In other words, the prices of bonds with low durations are less sensitive to interest rate changes. That means interest rates of longer-term bonds are higher than shorter-term bonds’. The term structure of interest rates should be graphed as a curve line of zero-coupon bonds, in fact, it describe the relationship between matures and coupon date.…

    • 741 Words
    • 3 Pages
    Satisfactory Essays
  • Good Essays

    BOND MARKET IN INDIA

    • 1939 Words
    • 8 Pages

    BONDS ARE INTEREST BEARING DEBT INSTUMENTS. In India Bonds are issued by Government of India, State Governments, and Corporate Sector. The different categories of Bond market in India are as follows:…

    • 1939 Words
    • 8 Pages
    Good Essays
  • Good Essays

    Banking and Finance

    • 630 Words
    • 3 Pages

    a. Define the term structure of interest rates. Briefly explain the theories of the term structure.…

    • 630 Words
    • 3 Pages
    Good Essays
  • Satisfactory Essays

    – DV01 = dollar value (of ∆P) of yield change, ∆y, = 1 basis point…

    • 545 Words
    • 10 Pages
    Satisfactory Essays
  • Satisfactory Essays

    Abacus Inc. has asked you price a 5 year bullet bond issue for them, with Price, Yield to Maturity and Modified Duration. There are no comparable existing issues in the secondary market either by Abacus or a competitor and so you will need to price the issue from scratch.…

    • 1096 Words
    • 5 Pages
    Satisfactory Essays
  • Good Essays

    We assume that the coupon interest is fixed, then the price of bonds(P)is the discounted cash flows of each period:…

    • 2562 Words
    • 11 Pages
    Good Essays