ABSTRACT
This chapter describes the fundamentals of term-structure modeling from the point of view of Arbitrage Pricing Theory. In the previous chapter we introduced the concept of s p o t termstructure on interest rates, which was illustrated in the construction of forward-rate curves and discount curves using market data. Here, we discuss probability measures that describe the e v o l u t i o n of these curves in an arbitrage-free economy. These probabilistic models are used for pricing interest-rate options, and other fixed-income derivatives with option features.
