Lecture 4: Yield Curve, Forward rates

Question 1

What is the yield curve

Answer 1

Graphical depiction of the relationship between yield on bonds of the same credit but different maturities. Often constructed from treasury markets.

Question 2

How do we find forward rates from yield curves

Answer 2

From the yield curve we can extrapolate theoretical spot rates, aswell as market consensus of future interest rates.

From there we can use formula:
F = (1+Z2)^n/(1+Z1)^n) -1

Question 3

What is maximum forward rate we can calculate?

Answer 3

Spot rates can be used to calculate forward rates for any time in the future for any investment horizon.

Question 4

Why are forward rates important, even though theyre often inncurate

Answer 4

Forward rate may never be realized but it is important in what it tells investors about his expectation relative to what the market consensus expects.

Question 5

Why are forward rates considered hedgeable rates

Answer 5

Some market participants consider forward rates to be hedgeable rate, because by buying the 1 year security, the investor can hedge the 6 month rate 6 months from now.