Term Structure of Interest Rates › Term Structure of Interest Rates
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How much is a payment in five years worth today? The answer need not use the same rate as a payment next year. The term structure of interest rates describes how rates vary across maturities at a single observation date. A bank's 1-year and 5-year certificates of deposit, for example, may offer different rates; a flat curve is also possible.
The graphical representation of this relationship is called the yield curve. Market participants and policymakers use curves to compare valuations and study the economic outlook. Their shape reflects expectations about future rates together with term premia and market supply and demand. A slope alone cannot separate these influences or identify a unique growth or inflation forecast.
For fixed-income valuation, we need discount rates at the dates when payments occur. One rate generally cannot summarize every maturity, although a flat curve is a useful special case. This chapter connects the curve's rate and discount-factor representations, then constructs them from instrument prices.