Forward rate

CFA Level II Fixed Income
#1

Per CFAI book pg 22

For the sake of simplicity, assume a flat yield curve of 8% and that a trader holds a three-year bond paying annual coupons based on a 8% coupon rate. Assuming a par value of 100, the current market price is also 100. If today’s forward curve turns out to be the spot curve one year from today, the trader will earn an 8% return.

If the trader projects that the spot curve one year from today is above today’s forward curve—for example, a flat yield curve of 9%—the trader’s expected rate of return is 6.24%, which is less than 8%:

(8+8/(1+0.09)+108/(1+0.09)2)/100−1=6.24

why have they not discounted the first coupon payment… 8/(1+.09) …?

#2

He receives three coupons: one a year from today, one two years from today, and one three years from today.

The calculation is the value of the bond plus its coupon one year from today. The trader just received a coupon payment of 8, so it’s not discounted. There are still two coupon payments left.

#3

Got it. So the value is based on one year from today.

Thanks

#4

My pleasure.