Question
Define yield curve. How is it constructed? How does interest rate risk influence the yield curve?
Answer :
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A yield curve is a graphical representation that shows the relationship between interest rates or yields and different maturities of debt securities, typically government bonds. It essentially depicts how the return on investment varies with the term to maturity, providing insights into investor expectations about future interest rates, inflation, and economic activity. The yield curve is a fundamental tool in international business finance, as it helps multinational firms, investors, and policymakers understand borrowing costs, investment strategies, and potential risks in global financial markets. The construction of a yield curve involves several steps. Firstly, relevant debt instruments must be selected, often focusing on government securities due to their low credit risk. The
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