ABSTRACT
This chapter provides coupon bonds from the perspective of the arbitrage-free pricing methodology. It shows that coupon bond is equivalent to a portfolio of zero-coupon bonds. A coupon-bearing bond is a loan for a fixed amount of dollars called the principal or face value. The loan extends for a fixed time period, called the life or maturity of the bond. A callable coupon bond is a coupon bond that can be repurchased by the issuer, at predetermined times and prices, prior to its maturity. The coupon bond’s cash flows can be obtained from a portfolio of zero-coupon bonds. The arbitrage-free pricing technique does not depend on a particular evolution for the term structure of interest rates. This makes the approach quite useful for pricing. The chapter also shows how to use the Heath, Jarrow, and Morton model to synthetically construct a coupon bond using fewer zero-coupon bonds than the number of payment dates.
