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Work out the arbitrage-free value of a straight fixed-coupon bond

CFA® Level II · Fixed Income · The Arbitrage-Free Valuation Framework · L2.FI.2.b

The idea

Value an option-free, fixed-rate bond by discounting each cash flow at the spot rate for its own date and adding the results: coupon ÷ (1 + S₁) + coupon ÷ (1 + S₂)² and so on, with the final cash flow including principal. Spot rates can come directly from strip prices or be bootstrapped from the par curve. The same answer comes from discounting through successive forward rates. A bond whose coupon exceeds the relevant spot rates trades above par. The frequent mistake is discounting every cash flow at a single rate, such as the longest spot rate or another bond's yield, instead of using the matching spot rate for each date.

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