The Treasury spot rate yield curve is closest to which of the following curves?
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The spot rate yield curve shows the appropriate rates for discounting single cash flows occuring at different times in the future. Conceptually, these rates are equivalent to yields on zero-coupon bonds. The par bond yield curve shows the YTMs on coupon bonds by maturity. Forward rates are expected future short-term rates.
James McDonald and Veasna Lu were discussing different ways of valuing a Treasury security. During their discussion Lu made the following statements:
Statement 1: It is inappropriate to discount the cash flows of a Treasury security by a single discount rate because that is implicitly assuming that the yield curve is flat. Therefore, each individual cash flow should be discounted by its corresponding spot rate.
Statement 2: The spot rates used for different time periods that produce a value equal to the market price of a Treasury bond are called forward rates or future expected spot rates.
With regard to the statements made by Lu:
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Statement 2 is incorrect because the spot rates used for different time periods that produce a value equal to the market price of a Treasury bond are called arbitrage-free Treasury spot rates. Statement 1 is correct.
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