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Question:
Consider the following information:
Statement 1: Generally speaking, the higher the level of interest rates, the smaller the difference between the stated annual rates for any two periodicities.
Statement 2: The feature that differentiates spot rates from yields to maturity on coupon bonds is that spot rates are yields that have no element of reinvestment risk.
Which of the following is most likely?
A
Only Statement 1 is incorrect.
explanation
Generally speaking, the lower the level of interest rates, the smaller the difference between the stated annual rates for any two periodicities.
Spot rates have no element of reinvestment risk, as they represent yields on zero-coupon bonds. Yields to maturity on coupon‐bonds make the assumption that all interim cash flows are reinvested at the stated YTM until maturity.
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