Fixed income - Bond valuation

CFA Level I Fixed Income
#1

  1. Bond spot rates are YTMs on zero coupon bonds maturing at the date of each cash flow. Why are zero coupon rates used for spot rates??

  2. What is the difference between normal spread and term structure of credit spreads? (I think term structure is the YTMs for different maturities. But I fail to understand the difference? Can anyone explain through a practical example?

#2

1- To standerdize the yield/price and duration?

2- You are correct. Term structure gives you the time premium spread of bonds with different maturities. A normal (nominal?) spread is the premium above Treasury securities for bonds with the same term.

#3

Because zeros have ALL cash flows loaded on a single maturity, their yields are the market’s assessment of the appropriate required rate on cash flows of that maturity

#4

Because the definition of a spot rate is a rate used to discount a single payment in the future back to today, and a zero coupon bond has a single payment in the future.

First, “normal spread” is not a recognized term. There are nominal spreads, and zero-volatility spreads (z-spreads), and option-adjusted spreads (OASs), and so on.

The term structure of credit spreads is a curve that shows credit spreads on the vertical axis vs. time to maturity on the horozontal axis. These spreads account for credit risk, and nothing else. Other spreads (nominal, z, OAS) account for all risks (e.g., liquidity risk, interest rate risk, currency risk, and so on), not just credit risk.

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