A) appropriate discount rate on the year 10 cash flow for a 20-year bond.
B) yield-to-maturity on a 10-year coupon bond.
C) yield-to-maturity on a 10-year zero-coupon bond.
The correct answer is B. The explanation given is A 10-year spot rate is the yield-to-maturity on a 10-year zero-coupon security, and is the appropriate discount rate for the year 10 cash flow for a 20-year (or any maturity greater than or equal to 10 years) bond. Spot rates are used to value bonds and to ensure that bond prices eliminate any possibility for arbitrage resulting from buying a coupon security, stripping it of its coupons and principal payment, and reselling the strips as separate zero-coupon securities. The yield to maturity on a 10-year bond is the (complex) average of the spot rates for all its cash flows.
Can somebody explain why the answer is not C. Zero coupon bonds pay not interests hence 10-year spot rate is not likely to anything to a zero coupon bond, isn’t so?