Fixed Income Securities
Rational pricing is one approach used in pricing fixed rate bonds. Here, each cash flow can be matched by trading in (a) some multiple of a zero-coupon bond corresponding to the coupon date, and of equivalent credit worthiness (if possible, from the same issuer as the bond being valued) with the corresponding maturity, or (b) in a corresponding strip and ZCB.
Given that the cash flows can be replicated, the price of the bond must today equal the sum of each of its cash flows discounted at the same rate as each ZCB, as above. Were this not the case, arbitrage would be possible and would bring the price back into line with the price based on ZCBs; see Bond valuation: Arbitrage-free pricing approach
The pricing formula is as below, where each cash flow is discounted at the rate that matches the coupon date:
- Price =
Often, the formula is expressed as, using prices instead of rates, as prices are more readily available.
See also Fixed income arbitrage; Bond credit rating.
Read more about this topic: Rational Pricing
Famous quotes containing the words fixed and/or income:
“The whole point about the true unconscious is that it is all the time moving forward, beyond the range of its own fixed laws or habits. It is no good trying to superimpose an ideal nature upon the unconscious.”
—D.H. (David Herbert)
“A sociosphere of contact, control, persuasion and dissuasion, of exhibitions of inhibitions in massive or homeopathic doses...: this is obscenity. All structures turned inside out and exhibited, all operations rendered visible. In America this goes all the way from the bewildering network of aerial telephone and electric wires ... to the concrete multiplication of all the bodily functions in the home, the litany of ingredients on the tiniest can of food, the exhibition of income or IQ.”
—Jean Baudrillard (b. 1929)