8 - Intro to Yield Curve Flashcards
Define Arbitrage?
The ability to make risk free profits. Arbitrage is the simultaneous purchase and sale of an asset to profit from a difference in the price. It is a trade that profits by exploiting the price differences of identical or similar financial instruments on different markets or in different forms. Arbitrage exists as a result of market inefficiencies.
Define Yield?
The yield to maturity of a fixed interest instrument.
Define Spot Rate?
The t-year spot interest rate is the interest rate on an investment that is made for a period of time starting today and lasting t years. It is the rate obtainable today for a deposit that s made today.
Define Cash Rate?
The yield offered by banks for investing cash over a specified term - normally 1-day up to a 3-months period.
Define Treasury Rate?
The yield offered by governments on cash invested over a specific term e.g. Yield on treasury bills -up to 3-months term.
Define Swap Rate?
The average rate at which banks will agree to enter a fixed float swap over a specified term.
What is a Yield Curve?
A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality but differing maturity dates. The most frequently reported yield curve compares the three-month, two-year, five-year and 30-year U.S. Treasury debt. This yield curve is used as a benchmark for other debt in the market, such as mortgage rates or bank lending rates, and it is also used to predict changes in economic output and growth.
What is a Par Yield Curve?
A curve which plots a combination of cash rates, treasury rates, futures rates, yields and swap rates.
What is Short End, Long End?
These refer to the early years on the curve and the later years respectively.
What is a Forward Yield Curve?
A curve showing the interest. rates that can be earned over a period of time where the accrual of interest starts at some point in the future. The curve therefor shows the expected interest rate at some point in the future.
What is a Zero-coupon Yield Curve?
A curve showing the interest rates that can be earned on instruments that pay no intermediate coupons. Zero coupon yield curves are normally constructed on a continuously compounded ACT/365 basis. The curve is thus a representation of the term structure of spot rates.
What are the 5 steps that need to be taken to reproduce a zero coupon curve and the associated curve?
1) Choose data points/instruments to construct the curve
2) DayCount Quotation and Compounding Bases
3) Intermediate Payments
4) Blending, Crossover Points and weighting
5) Interpolation and Extrapolation Methods
