ABSTRACT
A most common type of fixed income investment is a bond. Another example of a fixed income security is a coupon bond that provides regular payments (coupons) on a fixed schedule and a redemption value on the maturity date. The risk-free interest rate has been assumed to be a constant or a deterministic function for most of the option pricing models. A model for the term structure of interest rates and bond pricing can be developed from a model for the short rate process. A common drawback of the Merton model and the Vasicek model is that the short rate can be negative due to its normal distribution. The first tractable model for the short rate process that keeps rates positive was proposed by Cox, Ingersoll, and Ross model. The risk-neutral pricing formulae allow for computing no-arbitrage prices of any attainable claim. Pricing interest rate derivatives such as caps and swaps require a tractable model of floating rates.
