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Investment advice and corporate finance
Module 12Investment Management and Corporate FinanceA two-year bond pays a 5% annual coupon on RM100 face value. The one-year spot rate is 3.0% and the two-year spot rate is 3.8%. What is the bond's price?
Each cash flow is discounted at the spot rate for its own maturity: price = 5 ÷ 1.03 + 105 ÷ 1.038² = 4.854 + 97.453 = RM102.31. Discounting both cash flows at the two-year rate of 3.8% gives RM102.27, which undervalues the first coupon. Discounting both at the one-year rate of 3.0% gives RM103.83. Discounting at the simple average of the two spot rates, 3.4%, gives RM103.04. Only the matched spot rates give the arbitrage-free price. Source: SIDC M7 Study Outline Topic 4 Section B.3 Pricing Fixed Income Securities and A.4 Term Structure; CFA Institute Level I, 'Fixed-Income Bond Valuation: Prices and Yields' (as at October 2026).
Applying one rate to all cash flows. With a spot curve, the year-one coupon uses the one-year rate and the final payment uses the two-year rate.
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