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CFA Level I · CFA Level I Exam · The Term Structure of Interest Rates: Spot, Par, and Forward Curves

A 3-year zero-coupon bond is priced to yield a spot rate of 4.00% per year, with annual compounding. The discount factor for a cash flow received in three years is closest to:

The discount factor is 1 divided by 1.04 cubed, which equals about 0.8890. It is the present value of one unit received in three years at the 4% spot rate. Using 0.9615 would only discount for one year.

  1. A0.8890Correct
  2. B0.8900
  3. C0.9615

Explanation

The discount factor is 1/(1.04)^3. Since 1.04^3 = 1.124864, the factor is 0.88900, which rounds to 0.8890. The 0.9615 option is the one-year factor, 1/1.04, which ignores the three-year horizon.

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