What is a zero coupon yield curve?
4 This would be a return on investment in a zero coupon bond with a certain time in maturity. The zero coupon yield curve shows in a graphical form of return on zero coupon bonds with different periods to maturity. The reason for the construction of the zero coupon yield curve is to use as a basic tool in determining the price of many securities with fixed income.
The zero coupon bond does not pay interest, but instead carries a discount on the nominal value. The investor will therefore receive one payment of the nominal value of the bond for its maturity. This nominal value is the equivalent of the principal invested plus interest for bond life. The bond yield can be calculated on the basis of the amount of discount and adolescence to maturity and is equivalent to the internal return level of investment. This is the possibility to use a cash register account that is close to maturity as an equivalent of a bond with zero coupon and use a return on this binding to calculate the yield curve.
In each particular time, the interest rate depends on the financial instrument, for the investment. The yield curve sets a return on financial instruments such as bonds that have similar credit risk and currency, but for a different time until maturity. The horizontal axis of the graph is time to maturity and the vertical axis shows the yield. A typical yield curve would rise from left to right, as the yield increases with a longer maturity.
Bonds with a shorter period of time until maturity brings less risk for the investor and therefore has a lower return and risk and yield usually increases as soon as the maturity is prolonged. The flat yield curve of the mayor if the outlook is uncertain. If investors expected reduced inflation in the longer term, it could occur negative or downwards.
The price of a bond at any particular time depends on the market conditions, including the expectation of the TRHU with regard to future interest rate movements. The zero coupon yield curve could change with each fluctuation in the market sentiment or economic conditions. Changes in the yield curve of the zero coupon are useful as a guide to changes affecting the entire market. Therefore, the use of this basic tool can help investors and analysts understand the effects of these changes on a number of investments.