Jul 09

Difference between spot curve, forward curve, and yield to maturity (YTM) – 7 min screencast

by David Harper, CFA, FRM, CIPM

FRM |

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A simple comparison using a 2.5 year $100 par 6% semiannual coupon bond:

  • Spot rate: the yield for each cash flow that treats the cash flow as a zero-coupon bond. A coupon-paying bond is a set of zero-coupon bonds.
  • Forward rate: the implied forward rates that make an investor indifferent to rolling over; e.g., the two-year forward rate (1F2) makes a bond investor indifferent to investing in either (i) investing in the 2.5 year spot rate or (ii) investing in the 2.0 year spot and rolling over into the six month forward. That is: Return on 2.5 year spot = 2.0 spot * 1F2.
  • Yield to maturity (YTM, an IRR): the single rate that can be used to discount all of the bond's cash flows, in order to price the bond correctly. So the YTM is a flat horizontal line!

Screencast:

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