Which of the following approaches is not associated to valuation of bonds ?
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → Scottish-differential approach
Bonds are valued by three approaches: the present value approach (discounting the coupons and the redemption value), the relative price approach (comparing with the yields of similar bonds) and the arbitrage-free pricing approach (discounting each cash flow at its own spot rate).
There is no “Scottish-differential approach” in bond valuation, so Option (3) is the one not associated with it.
Note: It seems that there is a mistake in the original NTA paper, which prints “Arbitrage-face pricing approach” in Option (2) when it should read “Arbitrage-free pricing approach”. The question can still be solved, because the Scottish-differential approach is not a method of bond valuation in either reading.