Unlocking the Secrets of Interest Rates: How Term Structure Models Shape Finance
Interest rates change over time and with the length of the loan. They can be unpredictable over time and form a pattern known as a yield curve. Models help us understand how interest rates of different lengths change together. These models are important for valuing and managing risks of loans with changing interest rates. The difference between future and expected rates includes a liquidity premium made up of two parts: one from market risk and one from how prices and rates relate.