Pricing STRIPS

[Abid Hassan]

Hi,

I am working on pricing a STRIP bond for trading. These instruments will be used for the first time and there are no quotes available in the market as of now

Is there any place where I can get a model for pricing a STRIP so as to give a quote?

Thanks,
Abid

 

[doug reich]

Is this more complicated than discounting using the appropriate rate curve? Wherever you are working, you should be able to get such a curve.

 

[Abid Hassan]

There is no such Curve

Hi,

Many thanks for the reply

I am from India, and the deal is that we do not have a sovereign real ZCYC. We are expected to have a sovereign real ZCYC once the STRIPS become successful. That, is the reason why we are not able to decide a bid/ask two way quote when STRIPS would be traded for the first time

Thanks,
Abid

 

[Uncle Max]

If you don't have a yield curve how you can price anything?

In extreme scenario you can define the lowest and the highest projected interest rates, let's say 0.5% and 15% (I don't know about your rates environment) and discount cashflows to obtain bid (at the lowest rate) and ask (at the highest rate).

However, I don't think you will get a lot of trading action with this approach, because buyers and sellers will definitely use more sophisticated interest rate models to come up with a "fair" price.

 

[Abid Hassan]

There is a yield curve, but

In India, because of the nascent state of bond markets, we have a very flawed yield curve. More than half the bonds issued are illiquid, and trading only happens at extremely short tenors and 10 year tenor. Hence there is no "REAL" yield curve. All that we have is an approximate yield curve, which is derived by bootstrapping/ interpolation.

Coming to the model which you talked which is used by more sophisticated traders, how can one start rom scratch towards building such a model?

 

[Eugene Krel]

Try looking up this:
The Hagan & West paper on Interpolation Methods for Curve Construction

 

[Andy Nguyen]

You can even find a few good paper on building yield curve right here on Quantnet under the Files section
Example QuantNetwork - Financial Engineering Forum - Downloads - [Bank of Canada, Bolder] Yield Curve Modelling at
Look at Appendix on page 39

Do a search for curve in the Files section. There are about a dozen more.