I am a little bit confused with the answer of question 7.5 page 176 of frm handbook. I thought the answer was B can someone explain why it is A?
On page 174, there are two graphs - the top graph (Fig 7.3) depicts the situation described in Question 7.5. “Spot curve” = “zero-coupon yield curve” and “par yield curve” = “coupon-bearing bond yield curve”. For a proof/assertion of this, see footnote 4 on the bottom of page 174. To take the topic of forward rates vs. spot rates vs. par yield rates one step further, we can use the formula below (7.16) on page 173. For par yield rates, y_2 is used to discount both the cash flows at times 1 & 2. For spot rates, R_1 is used to discount the time 1 CF and R_2 is used to discount the time 2 CF. For forward rates, F(0,1) would be used to discount the time 1 CF and both F(0,1) & F(1,2) would be used to discount the time 2 CF.
Thanks, I got confused by the answer in the book. but now I have got it straight.