1. DCF Model
▪ Present value of the future cash flow based on the promised coupon and principal
▪ Standard tool for pricing of the bonds
▪ Quoted single interest rate, YTM(Yield-to-Maturity)
2. Fixed Income Premium
▪ E(r) = real interest rate + inflation risk premium + default risk premium + liquidity risk premium
(1) Real (risk-free) interest rate
▪ A single interest rate for a completely risk-free securities if no inflation were expected
▪ The time preference for the current vs future real consumption
▪ Future Value = Present Value + tan(Θ) = Present Value * (1+R)
(2) Inflation risk premium
▪ Compensation for expected inflation
▪ Norminal interest rate(r) = real interest rate(R) + inflation rate(i)
(3) Default risk premium
▪ Compensation for the possibility that the borrower can not make a promised payment
(4) Liquidity risk premium
▪ Compensation for the loss to be converted to cash
▪ Risk that can not be converted to cash when it is needed
