Overvalued Bond

N

nitish3861

New member
Joined
Apr 17, 2012
Messages
0
Reaction score
0
[question removed by moderator]
Can anyone explain why the bond is overvalued if the expected spot rate is higher than current forward rate
 
because, it is discounted using the “higher expected” spot rate at each cash flow date. yeilding a lower value compared to the current one.
 
Imagine you have to discount $100. The market discounts it at 5% so the PV=100/1.05=95.24
You believe the discount should be 10% so the PV should be 100/1.1=90.91. So you say the market is overvaluing the bond.
 
Expected spot rate = what the market actually is, when it happens
Forward rate = what was PERCEIVED to be the rate.
***
Step 1: Overvaluation = Perceived price > THE ACTUAL price,
Step 2: Perceived yield < Actual yield
Forward rate = perceived yield
Expected spot rate = Actual yield at ‘expected’ point of time
 
You must log in or register to reply here.
Back
Top