Bond Pricing
Overview
Fixed income pricing can be a complex subject, given the complexity of the contracts that are being priced. However,
the methods are reasonably precise, and can usually produce accurate numbers, in contrast to methods used to price
equities.
Pricing Fixed Income
The price for a fixed income instrument is the sum of three pieces.
{% Price = Present \, Value + Price \, of \, Default \, Risk + Option \, Price %}
- The
present value of the instruments cash flows.
-
The price of the default risk of the bond.
This is analyzed within a
credit risk framework.
That is, the price is adjusted downwards if there is credit risk.
- Whether there is an option for the obligor to pay earlier than the specified date. (Optionality)
(see derivatives)
