The Price Arbitrage Method
This has the benefit of allowing spot rates for say a ten year period to be derived directly without having to work out for every year period from a balanced portfolio as in the boot strapping method.
All we need here is a portfolio of bonds which are to some extent in short position form, and also in the form of a long position.
This creates a zero coupon, effectively, at the appropriate maturity time, so you need two bonds of the same maturity but with different coupons, as should be evident and clear by now.
As a concrete example, then, you can derive the spot rate (three year) from the following: a three year 10% and a three year 5% bond.
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