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Dear John,
1.Can you please explain how to estimate the spot yeild curve.How the yeid curve is estimated by specifically Iterative process ?
2. In Technical Article Bond Valuation and Bond Yield on ACCA webpage.In example 4 how examiner estimate annual spot yeid curve of 3.88 ,4.96, and 5.80.?
The market value is the present value of the future receipts discounted at the yields.
So for bond A, there is a receipt in 1 years time of 107 and the current market value is 103.
So the PV of 107 at the spot yield for 1 year is 103.
So 107 x (1/(1+r)) = 103; so r = 0.0388 or 3.88%For bond B, there is a receipt in one year of 6, which is discounted at the 1 year spot yield (of 3.88%) and a receipt in 2 years of 106.
So the present value = 6 x (1/(1.0388)) + 106 x (1/(1+r)^2)) = 102 (the market value).
If you solve this, then you get r (the two year spot yield) to be 0.0496 or 4.96%It is the same procedure for bond C.
(Iterative simply means that we need the first one to calculate the second one and then we need both them to calculate the third one)
Dear John,
One more thing in example 3 the examiner is valuing bond based on yield curvers i.e.
Spot yeild curves for bond as follow.
One year 3.5%
Two year 4%
Three year 4.7%
Four year 5.5%Can you please explain this example ,i didnt get how they derive the price of bond 98.57 and the impact of above spot yeild curves ?
They are discounting the interest of $5 per year and the repayment of $100 at the end of 4 years using the spot yield rate applicable – the 1 year rate for the interest in 1 year; the 2 year rate for the interest in 2 years, and so on.
When they write (for example) 1.035^(-1) it means the same as 1 / 1.035, which is discounting for 1 year at 3.5%.
Similarly 1.04^(-2) is another way of writing 1 / (1.04^2), which is discounting for 2 years at 4%
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