Yield curve and the term structure
In this chapter the concept of yield curve and the three types of risks that are present in the yield curve are illustrated: level risk, slope risk, and curvature risk. We describe the differences between price volatility and yield volatility. The chapter presents evidence that short-term interest rates are typically much more volatile than long-term yields. The concept of term structure of interest rates is introduced, and tools such as the spot rates of interest, forward rates of interest, and par bond yield curves are developed and illustrated with specific real-life examples. We show how coupon bonds can be built as a portfolio of zero coupon bonds. We explain strips and implied zeroes ...