Question

What are definitions and interpretation of Zero yield curve?

Answer 1

A Yield Curve is a graph showing Treasury Yield on the vertical axis and the corresponding maturities on the horizontal axis. This gives an approximation of the term structure of interest rates, as at the time of preparation.

A Zero Yield Curve is the Yield Curve constructed with yield on zero coupon bonds of different maturities taken as spot rates corresponding to that maturities. Zero Coupon bond, in turn, is the bond which has no periodical interest payments. The bond is issued and subsequently changed hands, at a discount to the face value. The only income stream to the investor is the redemption price. Income from this investment is the amount of discount.

An upward slopping curve indicate expectation of   higher spot rates for future terms and vice versa. The steepness of the slope indicates the degree of increase (for upward curve) or decrease (of downward curve) in the spot rates over the period mentioned. The only exception is the application of liquidity preference theory which indicate that a slight upward slope need not be because of higher future rate, but could be because of the inclusion of liquidity premium.

Spot rates are nominal rates which comprise of compensation for inflation and are the aggregate of real rate and inflation. Hence the variance in spot rates (nominal rates) largely attribute to the expectation regarding inflation in future.