Sorry, if it's a very rudimentary question. I mainly practice tax but have to deal with financial transactions from time to time where I have to benchmark option prices. I have usually used Hull's Derivagem (normal short-rate model) to calculate option prices on bonds. I have been assuming a flat term structure for simplicity.
However, I'm looking to relax this assumption and use a normal term structure. I have been told that the way term structure goes into Derivagem is as follows. For example, for a 10 year bond: at 1-year maturity, the bond has 9 years remaining until maturity, so we use a 9 year zero-coupon yield; at 2-year maturity, the has 8 years remaining until maturity, so we use a 8 year zero-coupon yield; and so and so forth.
This would give a term structure where yields will down as maturities go up. However, this is a bit counter intuitive to me. I thought we can derive a term structure by listing maturities in a chronological order and then the corresponding zero-coupon yields.
I'd really appreciate if someone could please clarify this concept for me.