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why is flat the no default rate to start with?S2000magician wrote:
First question:
If a bond is overvalued, then you’ve discounted the cash flows at rates that are too low. So you expect rates to be higher in the future: the expected spot rate is higher than the current forward rate.
Second question:
If the yield curve is flat at 5% and the z-spread is 200bp, then you’re discounting every cash flow at:
5% + 200bp = 7%.
If the coupon rate is 7% and you’re discounting each cash flow at 7%, the price will be par.
The 5% yield curve is risk-free: the market rates. That’s why you use it as the basis for the z-spread.
Because you’re constructing a z-spread from it.h21 wrote:
why is flat the no default rate to start with?S2000magician wrote:First question:
If a bond is overvalued, then you’ve discounted the cash flows at rates that are too low. So you expect rates to be higher in the future: the expected spot rate is higher than the current forward rate.
Second question:
If the yield curve is flat at 5% and the z-spread is 200bp, then you’re discounting every cash flow at:
5% + 200bp = 7%.
If the coupon rate is 7% and you’re discounting each cash flow at 7%, the price will be par.
The 5% yield curve is risk-free: the market rates. That’s why you use it as the basis for the z-spread.
It’s not, but it is arguably one of the most poorly explained.h21 wrote:also, i do think FI is the hardest section of them all errrr
one thing i am still confused about is when we compare a time point on a forward and spot rate, we say forward curve is higher or lower than the spot curve, we are saying, say at T=3, the forward rate is higher or lower than the spot rate, are we saying at the time 3, the rate to discount the cash flow back 6 month is higher or lower than the spot rate to discount the cash flow back to the starting point?S2000magician wrote:
Because you’re constructing a z-spread from it.h21 wrote:
why is flat the no default rate to start with?S2000magician wrote:First question:
If a bond is overvalued, then you’ve discounted the cash flows at rates that are too low. So you expect rates to be higher in the future: the expected spot rate is higher than the current forward rate.
Second question:
If the yield curve is flat at 5% and the z-spread is 200bp, then you’re discounting every cash flow at:
5% + 200bp = 7%.
If the coupon rate is 7% and you’re discounting each cash flow at 7%, the price will be par.
The 5% yield curve is risk-free: the market rates. That’s why you use it as the basis for the z-spread.
Why would you construct a z-spread from a yield curve that already contains risks? The point of the z-spread is to price all of the risks.
It’s not, but it is arguably one of the most poorly explained.h21 wrote:also, i do think FI is the hardest section of them all errrr
got cha, if i can only count how many hairs i pulled studying FI hahaS2000magician wrote:
That’s exactly what we’re saying.