Abstract
Up to now we didn’t take any credit risk into account but have been looking exclusively at market risk which, in the case of an interest rate instrument, is simply the risk that the default-risk free discount curve changes.
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Notes
- 1.
At least if interest rates are not negative, which is not always the case (e.g., CHF in 2012). However, as long as interest rates are not too strongly negative, more precisely, as long as the yield to maturity is still positive, the possible gain is still approximately the sum of all interest payments.
- 2.
Especially for bonds with priority of claim before other debts, such a scenario is quite plausible.
- 3.
For positive interest rates.
- 4.
Strictly speaking, the limit \(\bar {B}(t,T)=0\) in the case of Q(t, T) = 0 and R = 0 is excluded here. However, this borderline case of a sure default is not of practical relevance.
- 5.
Before the big bang things were a little more complicated. If the next coupon date was less than 30 days in the future, no premium was paid on that date. Instead, the premium for the first (short) period and the first full period was paid at the end of the first full period ( long stub).
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Deutsch, HP., Beinker, M.W. (2019). Credit Risk. In: Derivatives and Internal Models. Finance and Capital Markets Series. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-22899-6_20
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DOI: https://doi.org/10.1007/978-3-030-22899-6_20
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