Bond Yields spot rates and ytm

CFA Level I
#1

I understand that the YTM is the MARKET discount rate that’s used to discount a bonds future cash flows…

However, I’m not sure I fully understand the concept behind Spot rates. It says that spot rates are the market discount rates for a single payment to be received in the future… I get how you can compute a bond price using the spot rates but I I dont understand the concept behind it.

My guess/understanding is that you use spot rates because the market interest rates change in the future years and you discount each cash flow using the spot rate for that year? So the difference between the spot and ytm is that YTM uses the same discount rate for the entire life of the bond ? While the spot rate essentially “updates” the discount rate each year if the interest rate changes? So would the spot rate then give a more accurate price for the bond?

Can anyone help/explain if i’m thinking correctly?

#2

I guess this then brings me to another question about forward rates. It say’s Forward rates are yields for future periods. It sounds simple but I’m confused on this also.

I know this is wrong but my thinking is that… If it says that the spot rate in year 3 is 7% then… isn’t that the forward rate? AH.

I understand the difference between the spot rate and forward rate from just the definitions… But I really do not conceptually understand the difference.

#3

Maybe these links help:

http://finance.wharton.upenn.edu/~acmack/Chapter_05_app.pdf

http://www.investopedia.com/ask/answers/042315/what-difference-between-forward-rate-and-spot-rate.asp

http://www.investopedia.com/exam-guide/cfa-level-1/fixed-income-investments/forward-rates-versus-spot-rates.asp

Spot rates are known variable by establishing a contract and are basis for calculating forward rates.

#4

I think the first link helps. But I’m referring to spot and forward rates for bonds. I’m not sure the second link applies but I could be wrong. Thank you for your help - greatly appreciated.

#5

Thank to you too for keeping me in the mood:) Fixed income is definitely topic which I have to master in coming weeks.

#6

I wrote an article on this that may be of some help: http://financialexamhelp123.com/par-curve-spot-curve-and-forward-curve/

#7

Thank you, professor S2000.

#8

My pleasure.

#9

S2000 that article is genius! thank you very much. Makes much more sense now.

#10

S2000, this article write-up has sufficiently saved my ass, much appreciated

#11

You’re quite welcome.