reading 43 example 2

[danv0330]

The yield to maturity for a benchmark one-year annual-pay bond is 2%, for a benchmark two-year annual-pay bond is 3%, and for a benchmark three-year annual-pay bond is 4%. A three year, 5% coupon, annual-pay bond with the same risk and liquidity as the benchmarks is selling for $102.7751 today (time zero) to yield 4%. Is this value correct for the bond given the current term structure?
The first step in the solution is to find the correct spot rate (zero-coupon rates) for each year’s cash flow. The spot rates are 2%, 3.015%, and 4.055%.
how do they get those spot rates?

 

[Mosstastic]

You need to bootstrap… there are some articles out there that describe the process. Basically you need to find the spot rates for each period that discount the bond value back to par

 

[danv0330]

ok.. yr 2 is 100=3/1.02 + 103/(1.+x^2)
97.058824=103/(1.+x^2)
(103/97.058824)^0.5
.03015

 

[Mosstastic]

I am not sure they’ll ask us to bootstrap since it’s mainly a Level 1 concept, but here’s a link that you can check out that might be helpful:
http://financialexamhelp123.com/par-curve-spot-curve-and-forward-curve/

 

[danv0330]

Mosstastic wrote:
I am not sure they’ll ask us to bootstrap since it’s mainly a Level 1 concept, but here’s a link that you can check out that might be helpful:
http://financialexamhelp123.com/par-curve-spot-curve-and-forward-curve/

thank you.. R43 LOS b calculate the arbitrage-free value of an option-free, fixed-rate coupon bond
if they give you the the YTM then you will need to “bootstrap” like EOC 2