Fixed Income Analysis

by Fabozzi, Frank J.; Leibowitz, Martin L.

• ISBN13: 9780470052211
• ISBN10: 047005221X
• Edition: 2nd
• Format: Hardcover
• Copyright: 2007-01-22
• Publisher: Wiley

Summary

* The valuation of fixed income securities with embedded options

Author Biography

FRANK J. FABOZZI, PhD, CFA, CFP, is an Adjunct Professor of Finance and Becton Fellow at Yale University's School of Management. He is also Editor of the Journal of Portfolio Management, and a consultant.

Table of Contents

Foreword	p. xiii
Acknowledgments	p. xvii
Introduction	p. xxi
Note on Rounding Differences	p. xxvii
Features of Debt Securities	p. 1
Introduction	p. 1
Indenture and Covenants	p. 2
Maturity	p. 2
Par Value	p. 3
Coupon Rate	p. 4
Provisions for Paying Off Bonds	p. 8
Conversion Privilege	p. 13
Put Provision	p. 13
Currency Denomination	p. 13
Embedded Options	p. 14
Borrowing Funds to Purchase Bonds	p. 15
Risks Associated with Investing in Bonds	p. 17
Introduction	p. 17
Interest Rate Risk	p. 17
Yield Curve Risk	p. 23
Call and Prepayment Risk	p. 26
Reinvestment Risk	p. 27
Credit Risk	p. 28
Liquidity Risk	p. 32
Exchange Rate or Currency Risk	p. 33
Inflation or Purchasing Power Risk	p. 34
Volatility Risk	p. 34
Event Risk	p. 35
Sovereign Risk	p. 36
Overview of Bond Sectors and Instruments	p. 37
Introduction	p. 37
Sectors of the Bond Market	p. 37
Sovereign Bonds	p. 39
Semi-Government/Agency Bonds	p. 44
State and Local Governments	p. 53
Corporate Debt Securities	p. 56
Asset-Backed Securities	p. 67
Collateralized Debt Obligations	p. 69
Primary Market and Secondary Market for Bonds	p. 70
Understanding Yield Spreads	p. 74
Introduction	p. 74
Interest Rate Determination	p. 74
U.S. Treasury Rates	p. 75
Yields on Non-Treasury Securities	p. 82
Non-U.S. Interest Rates	p. 90
Swap Spreads	p. 92
Introduction to the Valuation of Debt Securities	p. 97
Introduction	p. 97
General Principles of Valuation	p. 97
Traditional Approach to Valuation	p. 109
The Arbitrage-Free Valuation Approach	p. 110
Valuation Models	p. 117
Yield Measures, Spot Rates, and Forward Rates	p. 119
Introduction	p. 119
Sources of Return	p. 119
Traditional Yield Measures	p. 120
Theoretical Spot Rates	p. 135
Forward Rates	p. 147
Introduction to the Measurement of Interest Rate Risk	p. 157
Introduction	p. 157
The Full Valuation Approach	p. 157
Price Volatility Characteristics of Bonds	p. 160
Duration	p. 168
Convexity Adjustment	p. 180
Price Value of a Basis Point	p. 182
The Importance of Yield Volatility	p. 183
Term Structure and Volatility of Interest Rates	p. 185
Introduction	p. 185
Historical Look at the Treasury Yield Curve	p. 186
Treasury Returns Resulting from Yield Curve Movements	p. 189
Constructing the Theoretical Spot Rate Curve for Treasuries	p. 190
The Swap Curve (LIBOR Curve)	p. 193
Expectations Theories of the Term Structure of Interest Rates	p. 196
Measuring Yield Curve Risk	p. 204
Yield Volatility and Measurement	p. 207
Valuing Bonds with Embedded Options	p. 215
Introduction	p. 215
Elements of a Bond Valuation Model	p. 215
Overview of the Bond Valuation Process	p. 218
Review of How to Value an Option-Free Bond	p. 225
Valuing a Bond with an Embedded Option Using the Binomial Model	p. 226
Valuing and Analyzing a Callable Bond	p. 233
Valuing a Putable Bond	p. 240
Valuing a Step-Up Callable Note	p. 243
Valuing a Capped Floater	p. 244
Analysis of Convertible Bonds	p. 247
Mortgage-Backed Sector of the Bond Market	p. 256
Introduction	p. 256
Residential Mortgage Loans	p. 257
Mortgage Passthrough Securities	p. 260
Collateralized Mortgage Obligations	p. 273
Stripped Mortgage-Backed Securities	p. 294
Nonagency Residential Mortgage-Backed Securities	p. 296
Commercial Mortgage-Backed Securities	p. 298
Asset-Backed Sector of the Bond Market	p. 302
Introduction	p. 302
The Securitization Process and Features of ABS	p. 303
Home Equity Loans	p. 313
Manufactured Housing-Backed Securities	p. 317
Residential MBS Outside the United States	p. 318
Auto Loan-Backed Securities	p. 320
Student Loan-Backed Securities	p. 322
SBA Loan-Backed Securities	p. 324
Credit Card Receivable-Backed Securities	p. 325
Collateralized Debt Obligations	p. 327
Valuing Mortgage-Backed and Asset-Backed Securities	p. 335
Introduction	p. 335
Cash Flow Yield Analysis	p. 336
Zero-Volatility Spread	p. 337
Monte Carlo Simulation Model and OAS	p. 338
Measuring Interest Rate Risk	p. 351
Valuing Asset-Backed Securities	p. 358
Valuing Any Security	p. 359
Interest Rate Derivative Instruments	p. 360
Introduction	p. 360
Interest Rate Futures	p. 360
Interest Rate Options	p. 371
Interest Rate Swaps	p. 377
Interest Rate Caps and Floors	p. 382
Valuation of Interest Rate Derivative Instruments	p. 386
Introduction	p. 386
Interest Rate Futures Contracts	p. 386
Interest Rate Swaps	p. 392
Options	p. 403
Caps and Floors	p. 416
General Principles of Credit Analysis	p. 421
Introduction	p. 421
Credit Ratings	p. 421
Traditional Credit Analysis	p. 424
Credit Scoring Models	p. 453
Credit Risk Models	p. 455
Case Study	p. 456
Introduction to Bond Portfolio Management	p. 462
Introduction	p. 462
Setting Investment Objectives for Fixed-Income Investors	p. 463
Developing and Implementing a Portfolio Strategy	p. 471
Monitoring the Portfolio	p. 475
Adjusting the Portfolio	p. 475
Measuring a Portfolio's Risk Profile	p. 476
Introduction	p. 476
Review of Standard Deviation and Downside Risk Measures	p. 476
Tracking Error	p. 482
Measuring a Portfolio's Interest Rate Risk	p. 487
Measuring Yield Curve Risk	p. 491
Spread Risk	p. 492
Credit Risk	p. 493
Optionality Risk for Non-MBS	p. 494
Risks of Investing in Mortgage-Backed Securities	p. 495
Multi-Factor Risk Models	p. 498
Managing Funds against a Bond Market Index	p. 503
Introduction	p. 503
Degrees of Active Management	p. 503
Strategies	p. 507
Scenario Analysis for Assessing Potential Performance	p. 513
Using Multi-Factor Risk Models in Portfolio Construction	p. 525
Performance Evaluation	p. 528
Leveraging Strategies	p. 531
Portfolio Immunization and Cash Flow Matching	p. 541
Introduction	p. 541
Immunization Strategy for a Single Liability	p. 541
Contingent Immunization	p. 551
Immunization for Multiple Liabilities	p. 554
Cash Flow Matching for Multiple Liabilities	p. 557
Relative-Value Methodologies for Global Credit Bond Portfolio Management	p. 560
Introduction	p. 560
Credit Relative-Value Analysis	p. 561
Total Return Analysis	p. 565
Primary Market Analysis	p. 566
Liquidity and Trading Analysis	p. 567
Secondary Trade Rationales	p. 568
Spread Analysis	p. 572
Structural Analysis	p. 575
Credit Curve Analysis	p. 579
Credit Analysis	p. 579
Asset Allocation/Sector Rotation	p. 581
International Bond Portfolio Management	p. 583
Introduction	p. 583
Investment Objectives and Policy Statements	p. 584
Developing a Portfolio Strategy	p. 588
Portfolio Construction	p. 595
Appendix	p. 614
Controlling Interest Rate Risk with Derivatives	p. 617
Introduction	p. 617
Controlling Interest Rate Risk with Futures	p. 617
Controlling Interest Rate Risk with Swaps	p. 633
Hedging with Options	p. 637
Using Caps and Floors	p. 649
Hedging Mortgage Securities to Capture Relative Value	p. 651
Introduction	p. 651
The Problem	p. 651
Mortgage Security Risks	p. 655
How Interest Rates Change Over Time	p. 660
Hedging Methodology	p. 661
Hedging Cuspy-Coupon Mortgage Securities	p. 671
Credit Derivatives in Bond Portfolio Management	p. 673
Introduction	p. 673
Market Participants	p. 674
Why Credit Risk Is Important	p. 674
Total Return Swap	p. 677
Credit Default Products	p. 679
Credit Spread Products	p. 687
Synthetic Collateralized Debt Obligations	p. 691
Basket Default Swaps	p. 692
About the CFA Program	p. 695
About the Author	p. 697
About the Contributors	p. 699
Index	p. 703
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