Arbitrage-Free Valuation Framework
Free CFA Level II lesson in Fixed Income. 12 min read, ~1,822 words.
Arbitrage-free principle: bond price = sum of PV of cash flows discounted at benchmark-consistent rates. Binomial tree: models short-rate evolution with lognormal up/down moves linked by r(up) = r(down) x e^(2 x sigma), which keeps rates positive. Calibration first: every benchmark bond must price at par before you value any...
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What this lesson covers
- Content
- Example 1
- Example 2
- Common Mistakes
- Check Your Understanding
- Exam Shortcuts
Learning objectives
- arbitrage free valuation
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