Question
Define yield curve. How is it constructed? How does interest rate risk influence the yield curve?
Answer :
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Skip in 10
A yield curve is a graphical representation that shows the relationship between the interest rates (or yields) of debt securities and their maturities, ranging from short-term to long-term. Typically, the curve plots the yields on government bonds (such as U.S. Treasury bonds) against different maturities, and it provides insights into investor expectations about future interest rates, economic conditions, and inflation. The shape of the yield curve is critical for assessing the state of the economy and is a key tool in international business finance, as it influences decisions related to borrowing, investment, and economic forecasting.
The construction of a yield curve begins with the collection of yield data for debt securities of varying maturities. The most commonly used reference is government bonds since they are considered risk-free. For example, the yield
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