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8.1 Introduction

The valuation of a fixed-rate option-free bond generally requires determining its future cash flows and discounting them at the appropriate rates.

Valuation becomes more complicated when a bond has one or more embedded options because the values of embedded options are typically contingent on interest rates.

Issuers and investors should understand how embedded options – such as call and put provisions, conversion options, caps, and floors – affect bond values and the sensitivity of these bonds to interest rate movements

Lesson Wrap-Up

This lesson should leave you able to explain the introduction in a fixed-income context and connect it to the decisions made by issuers, investors, or analysts.

Review Prompts

  1. Explain introduction in your own words.
  2. State one exam-style risk, valuation, or market implication of the introduction.