Price calculated using spot rates is called as no arbitrage price of a bond. Can someone explain this?
If everybody uses the same spot curve to discount cash flows, then everybody should come up with the same price for cashflows of identical amounts and timing.
Thanks!
If you buy a bond, strip it (i.e., separate the cash flows into individual securities) and sell the strips, you can make an arbitrage profit if the sum of the prices of the strips exceeds the price of the bond.
If you buy the strips and reconstitute the bond (i.e., tape them back together) and sell the bond, you can make an arbitrage profit if the price of the bond exceeds the sum of the prices of the strips.
Therefore, for there to be no opportunity for arbitrage, the price of the bond must equal the sum of the prices of the strips. And, as each strip is a spot payment (i.e., a single payment at a given future date), the prices of the strips are computed using spot rates.