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Study Session 12: Fixed Income: Valuation Concepts

Backward induction

I’ve seen inconsistency in CFAI official questions whereby if there is a three year bond, say the coupon is 5 so the value at year 3 is 105 for all nodes, for the second year some take 105/spot rate year 2 and that is the answer. Then some take 105/spot rate + coupon of 5.

Why am I seeing differences here? Is it to do with embedded versus non-embedded bond?

Thanks in advance 

Effective Durations!! Please help

Does anyone know why the book link the effective duration to the maturity of the bond? like a zero coupon bond ED = maturity of the bond? isnt ED measures the sensitivity of the bond price to the yield? came accross a lot of questions asking about strategy if you want to increase or decrease the duration of the portfolio? Can someone please kindly explain? thanks in advance!!!

Bonds with embedded call options issued at a premium?


The curriculum says that bonds with embedded call options are generally issued at a large premium, and at issuance, the calls are generally in the money.

Why would this be? It defies logic.

Why would investors pay a premium for something that goes against them (embedded call options)?


Market conversion price

Hi all!

I struggle a bit with understanding the concept of market conversion price. The price at which you can convert a bond is set at begining as initial conversion price and it defines conversion ratio as par / conversion price. So far so good right?

However as bond is traded, that initial conversion ratio is used to determine market conversion price as MV of bond / conversion ratio. That should tell you how much you are effectively paying for opportunity to profit from conversion right?

Now I got the example below that confused me:

Fixed Income - Int. Rate Tree

So I have been encountering a problem in a mock regarding this topic, basically the problem gives you the following information:

Bond with annual coupon of 4.5% with a par of 100 callable at 100.5 maturing in 3 years, int. rate volatility of 10%

The Value of the bond is ?

a)102.26            b)102.76           c)102.82

fixed income

How is that possible that country that does not have an active bond market, i.e. bonds for all maturities are not actively traded or do no exist at all, has an active swap market?

FI - OAS and relative value


If interest rate volatility declines then the relative cheapness of a callable will increase. As interest rate volatility declines, the OAS for callable bonds will increase—that is, the relative cheapness increases.

Can someone explain the above, I am struggling to understand why the OAS would increase if IR vol falls.

Many thanks

Convertible Bonds

Hi All,

I was soving the following question - please have a look.


For a convertible bond with a call provision, with respect to the bond’s convertibility feature and the call feature, the Black-Scholes option model can apply to:

A.)neither features.

B.)both features.

C.)only one feature

Correct answer: C)

Discount rates

Hi All,

I have a general question on discount rates.

When solving DCF models for semiannual coupon payments bonds  - sometimes the cash flows are discounted with annual discount rates and sometimes with semiannual rates. Could you please explain how I should identify whether I should use the semiannual or annual compounding if the question does not specify it?

Thanks many times,