Study Notes: Pricing Conventions, Discounting, and Arbitrage

Chapter 9. Pricing Conventions, Discounting, and Arbitrage Study Notes cover the following learning objectives:

* Define discount factor and use a discount function to compute present and future values.
* Define the “law of one price,” explain it using an arbitrage argument, and describe how it can be applied to bond pricing.
* Identify arbitrage opportunities for fixed income securities with certain cash flows.
* Identify the components of a US Treasury coupon bond, and compare the structure to Treasury STRIPS, including the difference between P-STRIPS and C-STRIPS.
* Construct a replicating portfolio using multiple fixed income securities to match the cash flows of a given fixed- income security.
* Differentiate between “clean” and “dirty” bond pricing and explain the implications of accrued interest with respect to bond pricing.
* Describe the common day-count conventions used in bond pricing.

After reviewing the notes, you will be able to apply what you learned with practice questions.

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