17) Interest rate models and bonds Flashcards
(8 cards)
1
Q
What is a bond and what is a zero-coupon bond
A
- A bond is a financial contract, paid up front that pays a known amount at a known future date (the maturity date, t=T)
- Bonds may also pay fixed cash dividends (called coupons) at regular intervals.
- A zero-coupon bond is a bond with no coupon payments — it pays only a single lump sum at maturity.
2
Q
How do you price a zero-coupon bond when the interest rate is deterministic
A
3
Q
What is the price of a bond that pays a single coupon Z1 at time T1 and face value Z at maturity T>T1
A
4
Q
How do you find the price of a bond that pays finite coupons (K) and infinith coupons (K → ∞)
A
5
Q
Why is pricing a bond trickier than pricing an option and what do we do to hedge
A
- Pricing a bond is hard since there is no underlying asset with which to hedge: we cannot go out and buy an interest rate of 5%
- Instead we hedge with bonds of different maturity dates
6
Q
How can we model interest rates stochastically
A
7
Q
In a portfolio long one bond V1 and short Δ bonds V2, how should Δ be chosen to eliminate randomness
A
8
Q
What is the Black-Scholes-type PDE for bond prices under a short-rate model
A
