16 MATHEMATICAL TECHNIQUES IN FINANCE

103%

102%

101%

100%

99%
2 1.5 1 0.5 0
Years to Maturity

FIGURE 2.2 Price of bond versus remaining years to maturity.

a bond, and they prefer a smoother measure. By subtracting the accrued

interest, wC∕m, from the dirty price, one arrives at the Clean/Quoted Price
[ ( ) ]
w C 1 1 C
PClean = (1 + y∕m) 1− + −w (2.7)
y (1 + y∕m)N (1 + y∕m) N m

In Example 1, the clean price of the bond is

0.04
1.0197889 − 0.54348 × = 1.0089194 = 100.89194%
2

Even though the clean price is quoted, the amount paid for the bond uses
the true economic value of the remaining cash flows, that is, the dirty price
of the bond.
Figure 2.3 shows the evolution of the clean price for a 2-year, 4% semi-
annual coupon bond as we get closer to maturity while holding yields con-
stant for three yield scenarios: y = 5% leading to a discount bond (C < y),
y = 3% leading to a premium bond (C > y), and y = 4% leading to a par
(C = y) bond. Notice the Pull-to-Par Effect for the bond regardless of the
assumed yield scenario: A discount bond gets pulled up to par, while a pre-
mium bond gets pulled down to par.