CFA® Preparation FIXED INCOME www.dbf-finance.com
Reading Reading Title Study Session Number
32 The Term Structure and Interest Rate Dynamics 12 33 The Arbitrage-Free Valuation Framework
Valuation and Analysis of Bonds with Embedded 34 Options
35 Credit Analysis Models 13
36 Credit Default Swaps
Luis M. de Alfonso CFA® Preparation FIXED INCOME www.dbf-finance.com
The Term Structure and Interest Rate Dynamics
Study Session 12
Reading Number 32
Luis M. de Alfonso CFA® Preparation FI – The Term Structure and Interest Rate Dynamics www.dbf-finance.com
LOS 32.a: Describe relationships among spot rates, forward rates, yield to maturity, expected and realized returns on bonds, and the shape of the yield curve
SPOT RATES Ø Annualized market interest rate for a simple paymentto be received in the future Ø Normally we use spot ratesfor government securities to generatethespot rate curve Ø Spot ratescan be interpreted as the yieds on zero-coupon bonds (sometimes are referredas zero-couponrates)
P = discount factor (price today of a 1$ par zero-coupon bond) Price of a zero-coupon bond P = S = spot rate (yield to maturity) (discount factor) T = maturity
The termstructure of spot rates(graphof the spot rate S versus thematurity T) is known as the spot yield curve or spot curve
Shape of spot curve changescontinously with the market prices of the bonds
Luis M. de Alfonso CFA® Preparation FI – The Term Structure and Interest Rate Dynamics www.dbf-finance.com
LOS 32.a: Describe relationships among spot rates, forward rates, yield to maturity, expected and realized returns on bonds, and the shape of the yield curve
FORWARD RATES Ø Annualized interest rate on a loan to be initiated at a future period Ø The termstructure of forward ratesis called the forward curve Ø Forward curves and spot curves are mathematically related(we can derive one from the other)
f (j,k) = the annualizedinterest rate applicableon a k-year loan starting in j years
k