Arbitrage-Free Valuation Framework
Free CFA Level II lesson in Fixed Income. 11 min read, ~1,709 words.
Arbitrage-free principle: bond price = sum of PV of cash flows discounted at benchmark-consistent rates. Binomial tree: calibrate to benchmark, then backward induction to value. Sequence is strict. Backward induction: V(node) = [0.5 x (V(up) + V(down)) + coupon] / (1 + r(node)). Pathwise valuation produces the same price as...
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What this lesson covers
- Content
- Example 1
- Example 2
- Common Mistakes
- Key Takeaways
- Exam Shortcuts
Learning objectives
- arbitrage free valuation
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