The value of a zero-coupon bond with a par value of 1 at time t and a prevailing interest rate, r, is defined as follows:
Since the interest rate, r, is always changing, we rewrite the zero-coupon bond as follows:
Now, the interest rate, r, is a stochastic process that accounts for the price of the bond from time t to T, where T is the time to maturity of the zero-coupon bond.
To model the interest rate, r, we can use one of the short-rate models as a stochastic process. For this purpose, we will ...
