This study session introduces the yield curve and key relationships underlying its
composition. Traditional and modern theories and models explaining the shape of
the yield curve are presented. An arbitrage-free framework using observed market
prices is introduced for valuing option-free bonds. This approach also holds for more
complex valuation of bonds with embedded options and other bond types.
Reading 34 The Term Structure and Interest Rate Dynamics
Reading 35 The Arbitrage-Free Valuation Framework
STUDY SESSION 13 Fixed Income (2)
This study session continues use of the binomial valuation method to value bonds
with embedded options. Sensitivity to interest rates and interest rate volatility are key
considerations. Option-adjusted spreads are introduced for the evaluation of risky
bonds. Credit analysis concepts, tools, and applications are then discussed along with
the term structure of credit spreads. The study session concludes with credit default
swaps and their use in managing credit exposure.
Reading 36 Valuation and Analysis: Bonds with Embedded Options