Chapter 18Interest Rate Derivatives
A zero-coupon bond can be the underlying asset for forwards and options, in the same way as a stock. The price 
of a zero-coupon bond is 1 at the expiration, so that 
; but for 
, the price 
is a random variable, in the same way as stock price 
is a random variable. The forward price of a zero-coupon bond can be found by an arbitrage argument, in the same way as the forward price of a stock. A coupon-bearing bond can be expressed as a portfolio of zero-coupon bonds, so that much of the pricing of coupon-bearing bonds can be done with the help of pricing of zero-coupon bonds.
A forward rate agreement (FRA) allows to change a floating rate 
against a fixed rate 
, where is typically a Libor rate. Thus, the payoff of a forward rate agreement is of type
The ...
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