Module 55. Term Structure of Interest Rates

Question 1

How is the YTM Calculated?

Answer 1

As if the discount rate for every bond cash flow is the same, when instead it varies according to the time period

Question 2

What are spot rates?

Answer 2

Discount rates for a single payment to be recievefd in the future and are observed by calculating the discount rate for zero coupon bonds?
Or YTM for default risk free zero coupon bonds

Question 3

Why are zero coupon bonds used a spot rates

Answer 3

They have the same currency, credit risk, liquidity and tax, and further they have no coupon reinvestment risk.

Question 4

How do you calculate a bond price using spot rates

Answer 4

Coupon / (1+Spot rate)^1….. sum all of them up together

Question 5

What are par yields and how do you calculate them?

Answer 5

These are the coupon rate that each bond at maturity would need in order to be priced at par PMT / DR^1 + PMT / DR^2 = 100.
Plug in the option in the exam to see what the par coupon rate is, and thus what the par YTM as they’re equal when a bond is trading at par

Question 6

What is the Spot Rate Yield Curve?

Answer 6

Is a plot of spot rates vs maturities - it is usually upwards sloping, with higher spot rates for longer maturities, reflecting investor demands for higher returns over longer time frames

Question 7

What’s an issue with yield curves for coupons

Answer 7

practical issue with constructing yield curves directly from traded coupon bond prices is that distortions in yields can occur due to illiquidity and taxation differences between interest income and gains and losses from buying bonds at a discount or premium

Question 8

What is the relationship between the Spot and Par Curves?

Answer 8

Spot rate - Spot Rate and Par Rate are essentially identicial, but the par rate is below the spot rate

Question 9

What is the term structure of interest rates?

Answer 9

Factors explaining the difference between yields on different times of maturity, excluding credit risk, tax, liquidity, etc