PPT Slide
Example (construction of a zero-coupon instrument)
Bond A: 10-year bond with 10% coupon; PA = $98.72.
Bond B: 10-year bond with 8% coupon; PB = $85.89.
Both bonds have the same par of $100.
Construct a portfolio of –0.8 unit of bond A and 1 unit of bond B. Resulting face value is $20, and price is PA - 0.8 PB = 6.914.
The coupon payments cancel, so this is a zero coupon portfolio. The 10-year spot rate is given by
(1 + S10)10 ? $6.914 = $20