I understand how spot rates are different from forward rates, and I understand how YTM relates to par.
What’s not clear to me is why there’s a difference between spot and YTM.
My understanding is that both spot rate and YTM is the IRR of a bond that hasn’t matured yet. What am I missing here?
Is it that the word “spot” implies a zero coupon but YTM may or may not include coupon payments? If so, why would that matter? Reinvestment risk?
A spot rate is a discount rate for a single payment.
The YTM for a bond is the single discount rate for all of the bond’s payments.
For a zero coupon bond, the YTM is the spot rate for the bond’s maturity. For a coupon-paying bond there will be more than one relevant spot rate (one for the maturity of each payment, coupons and par), and it’s unlikely that the YTM will equal any of the spot rates; if it does, it’s a coincidence.
For example, if you have a 2-year, annual pay bond and the relevant spot rates are:
then the YTM will be somewhere between 3% and 4%, and closer to 4% than 3%. Exactly what it will be depends on the bond’s coupon rate.