This study session introduces the yield curve and key relationships underlying its composition. Traditional and modern theories and models explaining the shape of the yield curve are presented. An arbitrage-free framework using observed market prices is introduced for valuing option-free bonds. This approach also holds for more complex valuation of bonds with embedded options and other bond types.

This study session continues use of the binomial valuation method to value bonds with embedded options. Sensitivity to interest rates and interest rate volatility are key considerations. Option-adjusted spreads are introduced for the evaluation of risky bonds. Credit analysis concepts, tools, and applications are then discussed along with the term structure of credit spreads. The study session concludes with credit default swaps and their use in managing credit exposure.