ABSTRACT

This chapter covers financial contracts that depend on interest rates. The market that trades interest rate contracts is known as a fixed income market. The main message of this chapter is that the interest rate traded on the exchanges or on the over-the-counter markets is just a special case of the concept of price, and thus the pricing techniques developed in the previous chapters immediately apply to the interest rate market as well. The interest rate is distinct in the sense that the corresponding reference asset is not a currency, but rather a bond, or a portfolio of bonds. Thus the numeraire approach to use a bond as a natural reference asset is especially helpful in the determination of the price of the interest rate contracts.