Lesson 1 of 6 · 12 min
Spot rates and the spot curve
A spot rate is the yield on a default-risk-free zero-coupon bond, and the spot curve plots those yields against maturity so that time-to-maturity is the only thing that differs.
In short
- Yields differ for many reasons: credit risk, currency, liquidity, tax and periodicity. The part explained by time-to-maturity alone is the term structure (maturity structure) of interest rates.
- A spot rate (zero rate) is the yield-to-maturity on a default-risk-free zero-coupon bond. The set of spot rates across maturities is the spot curve (zero or strip curve).
- Zeros are the ideal data: same issuer, currency, liquidity and tax status, and no coupon reinvestment risk.
- The normal shape is upward sloping, flattening at long maturities. A downward-sloping curve is inverted.
- In practice, analysts use the most recently issued, actively traded government bonds (priced near par) and interpolate between them.
- All points on the curve must use the same periodicity; money market rates are converted to bond equivalent yields first.
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