Abstract. A standard method to price exchange-traded fixed income derivatives is through a noarbitrage argument based on a replicating portfolio. This method is not applicable to exotic client-based derivatives, due to liquidity or transaction cost problems with replication. Based on a time-homogenous Markov process for the underlying interest rate, we derive a pricing model that uses a state-conditioned distribution of pay-offs for a family of client-based fixed income derivatives. The method is flexible for pricing various financial securities.