Theories And Application Of Interest Rate Term Structure

Term Structure is the curve formed by interest rates of different maturities. It is the benchmark for asset pricing, financial product design, hedging, risk management, arbitrage and speculation. Therefore, the research on term structure is always one of the basic financial field. With the development of financial markets, the deepening of financial innovations and the market-oriented process of interest rate, the importance of term structure research is more and more obvious.In the first part of this article, I reviewed the history and situation of term structure theory and market. Traditional theory focused on how to explain the characters of the term structure, which can be divided into three orientations– expectations theory, segmentation theory and liquidity preference theory. Since 1970's modern theory has been developed prospectively. Briefly, one of two key directions is static theory, whose target is to abstract the term structure of one day, the other key direction is dynamic theory, which focus on how to prospect and describe the future term structure of interest rate, some classical and popular modern have been reviewed, such as bootsrap method for static theory, CIR model and BDT model for dynamic theory.Secondly, on the base of bootstrap method, one new way is suggested in this article, which composed of some spirit of interpolation method. Considering the characteristic of Chinese government bonds market, a computer program is suggested to abstract the term structure from the daily market data automatically.The lastly, I composed the dynamic term structure of USA government bonds market under the BDT model and then priced one Foreign Currency Structure Deposit of Chinese market, in which some practice skills are showed for the pricing of interest rate derivatives.