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Security Valuation - Fixed Income - 14th question
AFM
Dear Sir, In Bhramstra Question no. 14 in Bootstrapping method, while calculating rates I have a query. I attached below. Which method is correct. In both methods rates may differ. Kindly explain.
Answers (4)
Thread Starter
PG BhanusreeSir 'r' denotes same spot rate which other faculty mentioned. Which one is correct method??
Spot rate is the rate applicable for discount a cash flow of a specific period In case of a ZCB spot rate is same as YTM in case of coupon bonds spot rate is applicable only for a specific year and not every year. So if we have to discount all cash flows of a 3 year coupon bond, each cashflow is discounted by a diff spot rate forward rate is the rate that is applicable for a for a specified period after a a few years, usually we talk of 1 year spot rates only eg forward rate for loan from year 2 to 3 i.e a year loan after 2 years from now Spot rate for year 0-1 is same as fwd rate rate for period 0 to 1 After the first year for alll subsequent years spot rates and forwards usually are not same ( even if they are it is a coincidence and not because of any formula) In your image only first equation is correct second equation second term denominator has to be ( 1+s1) x ( 1+f1,2) Whether you call spot rate as s or r does not matter as long as you use it consistently
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