Zero Coupon Bond And Yield Curve  

       Zero coupon bonds are different from other bonds wherein there are not interest payments during the term of the bonds. The investor receives a lump sum payment when the bond matures and this is equal to the initial investment and the interest. The interest is compounded semiannually at a specific yield.

       The yield to maturity of the bond is related to the internal rate of return in the bond market. Yield curve is one way of reproducing what is happening in the market. Usually a yield curve is a graph of internal rates of return of a bond right through until it reaches maturity.

       A yield curve is also known as spot yield curve, and a yield curve of zero coupon bond can be gotten from par yield curve and it is used to get discount factors. A yield curve of a zero coupon bond is formed by the expectation of how short-term interest rates will move and by how uncertain this move is. This uncertainty has effects on the yield curve in two ways -- one is investor’s dislike for risks and the other the relationship between yield and bond price.

      The calculation of all future rates is done based on the zero coupon yield curve. This means that if an investor knows the zero coupon yield curve, he will get to know the future rates of coupon bearing and non-coupon bearing bonds. To make simpler, financial advisers will tell you that zero coupon yield curve is the price of cash flows over a period of time and this can be derived from calculating Net Coupon yield curve of a bond for the period of time being taken into consideration.

      However, to read the yield curve correctly, you need to have the proper tool to do a yield curve analysis otherwise everything will be in vain and you will not get the correct readings.

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Zero Coupon Bond And Yield Curve




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