Term Structure Theories

Term Structure Theories

 

 

Summaries

 

  1. Pure Expectation Theory

·         Forward rate is a function of future spot rate

·         E.g. 2F0= 1F0 * 1F1

·         Can explain +ve, flat and –ve yield curves

  1. Liquidity Theory
    • There is liquidity premium (>0) for large maturity contracts
    • n-year spot rate = average forward rate + liquidity premium (annualized)
    • Can explain +ve, flat and –ve yield curves
  2. Preferred-Habitats Theory

·         Premium required to attract participants (borrowers and lenders) to shift from their preferred habitats (range of maturity) to other less-preferred one

·         Premium can be +ve or –ve

·         Can explain any kind of curves (e.g. Bump)

 

 

February 21st, 2008 in CFA - LEVEL 2, Fixed Income Posted by Editor

2 Comments

AdministratorFebruary 25th, 2008 at 11:35 pm

Unbiased expectation Theory is pure expectation theory

AdministratorFebruary 28th, 2008 at 2:36 pm

Notation of forward rate:

mfn – m period forward rate ****from n periods. Memorize “f” as “from”.

Leave a comment

Your comment