Risk management starts with the pricing ofassets. The simplest assets to study are regular, fixed-coupon bonds. Because their cash flows are predetermined, we can trannslate their stream of cash flows into a present value by discounting at a fixed yield. Thusthe valuation of bonds involves understanding compounded interest, discounting, and the relationship betwe,en present values and interest rates.
      Risk management goes one step further than pricing, however. It examines potential changes in the price of an asset as the interest rate changes. In this chapter,we assume that there is a single interest rate, or yield, that is used to price the bond.This will be our fundamental risk factor. This chapter describes the relationship between bond prices and yield and presents indispensable tools for the management of fixed-income portfolios.
       This chapter starts our coverage of quantitative analysis by discussing bond fundamentals. Section l.1 reviews the concepts of discounting, present values, and future values. Section l.2 then plunges into the price-yield relationship. It shows how the Taylor expansion rule can be used to relate movements in bond pfices to those in yields. The Taylor expansion rule, however, covers much more than bonds, It is a building block of risk measurement methods basecl on local valuation, as we shall see later. Section l.3 then presents an economic interf)retation of duration and convexity.
     The reader should be forewarned that this chapter, like many others in this hand-book, is rather compact. This chapter provides a quick review of bond fundamentals with particular attention to risk measurement applications. By the end of this chapter, however, the reader should be able to answer advanced FRM questions on bond mathematics.