Option-free bond
A bond neither side can end early. Its convexity works only in the holder's favour, which is exactly what an embedded option takes away.
Where you will meet it
Option-free bond appears in 14 learning outcomes on the CFA syllabus. A few of them:
- Explain bond terms that depend on contingent events
“In every case the option belongs to one party, and its value moves the bond's price in that party's favour relative to an otherwise identical option-free bond.”
- Contrast valuing with the zero-coupon yield curve and valuing with an arbitrage-free binomial lattice
“For an option-free bond, pricing with the zero-coupon curve and pricing on a calibrated binomial lattice give the same value, because the lattice was built to reproduce that curve and fixed cash flows do not depend on which path rates take.”
- Explain how price moves against yield and why bonds trade at a premium or discount
“Convexity is a benefit to the holder, which is why a duration-based estimate always understates the price of an option-free bond.”
- Use modified duration to estimate how a bond's price will change
“The estimate is a straight line drawn against a curved relationship, so it is accurate only for small moves; convexity is the correction for the curvature, and for an option-free bond it works in the holder's favour — prices rise more than duration predicts and fall less.”
See also
Practise it
Practise option-free bond until it is automatic: questions that explain every wrong option.
Take the free diagnostic →