When the zero curve is upward-sloping, the zero rate for a particular maturity is greater than...

When the zero curve is upward-sloping, the zero rate for a particular maturity is greater than the par yield for that maturity. When the zero curve is downward-sloping the reverse is true. Explain why this is so using FORMULAS

Expert Solution

The yield that is derived from the coupon bearing bond is known as the par yield. The zero rate is derived from the zero coupon bonds. When the zero curve is upward sloping, the zero rate is higher than the par yield for the n maturity because yield on the coupon bearing bond is calculated at a discounted value in comparison to the zero coupon bonds. In contrast to it, when the yield curve is downward sloping the yield on the coupon bearing bond is higher than the yield on the zero coupon bond.

Yield on a zero coupon bond formula is:

Yield to Maturity = (Face value / Current bond price)^(1/ years to maturity)-1

Yield to Maturity formula on coupon bearing bond is:

C= Interest Payment

FV = Face Value

Pv= Present Value

t= time period of maturity

Thus, from the above formulas it is clear that yield on the coupon bearing bond is calculated by considering the present value which is the discounted value of cash flows. In contrast, zero coupon bond doesn't consider the discounted values of cash flow.

jeff jeffy answered 1 year ago

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