A Primer on Risk-Free Bonds
This note explores the first principles of pricing financial contracts. Debt contracts go by many names, but the term bond is used in this note to denote any market-traded debt contract. The note is divided into three sections. The first section examines the simplest of financial contracts-the zero-coupon risk-free bond contract. The second section examines bonds with the additional complexity of coupon payments. The third section examines the expectations theory, the fundamental theory for why yields vary over different maturities, and introduces the construct of a yield curve. The basic concepts and principles associated with the risk-free bonds discussed in this note provide an important foundation for understanding more complex securities.