Why does a G-spread assume that the discount rate is constant for all cash flows?
The G-Spread assumes the same discount rate for all cash flows because it’s supposed to be added onto the YTM of a government bond to account for a corporate bond’s credit risk.
In other words, if you had a government bond, the YTM of that bond would be the discount rate that would discount each cash flow in order to arrive at the Present Value of the bond.
However, a corporate bond is more risky than a government bond, because it has credit risk. So you wouldn’t discount a corporate bond’s cash flows by the same discount rate as a government bond, you would need to account for that credit risk by incorporating a spread onto the government bond yield. That is what the G-Spread is for.
I see so the G-spread is the spread added to the government YTM to arrive at the corporate bond YTM and since YTM is the single discount rate that makes the present discounted value of cash flows equal the price and so G-spread is associated with a constant discount rate.
Let me know if this makes sense.
Yes. Because the YTM is the constant discount rate for every cash flow, the G-Spread is the spread that is added on to account for credit risk.