Spot rate and BEY question, problems, sometimes, like

edgeon

Hopefully this is a simple question - but I feel like I keep running into problems when either valuing a bond or doing arbitrage where sometimes the spot rate given needs to be divided by 2 and sometimes it needs to be left alone for discounting.

Does it have to do with the BEY? Or should the spot rate always be divided by 2 in all cases?

Thanks.

Londonrocks

Thanks! That makes sense.

pogo

Since most bonds are SEMI ANNUAL pay, if you are asked to compute the arbitrage valuation they will give you 6 month, 12 month, 18 month, 24 month spots but they will probably be annualized. You should divide em by 2, and use the appropriate discount factor to discount all the coupons and principal + final coupon.

If you are only given annualized rates, and the bond is an annual pay, then just discount each coupon by the corresponding spot, don't have to divide by 2 or anything.