Is the statement correct? Spot rate is a BEY rate, we can’t use it to discount cash flow, we should divide it by 2 and elevate it to power n years to discount cash flows
it depends on which instrument you are looking at.
I’m looking at fixed income bonds
it would help if you give a specific example.
Spot rates are zero coupon rates, so I believe that you’re statement is incorrect.
It’s a practice problem, I checked the answer, the statement is correct because of the semi-annual coupon payment tradition in U.S. for example, a 2 year bond has 4 cash flows, 1 year spot rate and 2 year spot rates are given, we divide the 1 year spot rate by 2 to discount the first coupon payment, and elevate it to power 2 to discount the 2nd coupon payment, and so on
Yes, if we assume that the coupon payments are made half yearly you need to divide the spot rate by 2 and power it to discount the coupon. If the coupon payments are made annually you don’t need to do that. But I think your example is partially incorrect: To discount the first coupon payment you need to divide the spot rate associated with 0.5 years by 2. Similarly, for the second coupon paytment you need to divide the spot rate associated with 1 year by 2.
also, treasury spot rates are expressed as semiannual-pay yield to maturity, so if you’re told to have a spot rate for 6 month as 4%, for 1 year as 5%, for 1.5 year as 6%, etc. the discount rate should be ( 4% / 2 ) ^ (0.5) = 1.41% for 6 month ( 5% / 2) ^ 1 = 2.5% for 1 year ( 6% / 2) ^ (1.5) = 5.20% for 1.5 year please confirm what I wrote above is correct.
Here is the how it can be done: the discount rate should be ( 4% / 2 ) ^ (1) = 1.41% for 6 month ( 5% / 2) ^ 2 = 2.5% for 1 year ( 6% / 2) ^ (3) = 5.20% for 1.5 year Note: I have changed the powers, this is because your discount rates are in half yearly format.
Thanks, actually it should be: ( 4% / 2 ) ^ (1) = 2% for 6 month ( 5% / 2) ^ 2 = 6.25% for 1 year ( 6% / 3) ^ (3) = 8% for 1.5 year
It should be: For 6 month: (1 + 4%/2)^1 For 1 year: (1 + 5%/2)^2 For 1.5 year: (1 + 8%/2)^3 Sorry for the mistake in earlier post.