Fixed-Income Analysis for the Global Financial Market Money Market, Foreign Exchange, Securities, and Derivatives

by Questa, Giorgio S.

• ISBN13: 9780471246534
• ISBN10: 0471246530
• Edition: 1st
• Format: Hardcover
• Copyright: 1999-07-22
• Publisher: Wiley

Summary

This comprehensive new book explains and clarifies the essential building blocks underlying the pricing and risk analysis of fixed-income securities and derivatives - using mathematics lightly, to make things easier, not harder. The emphasis throughout is on how-to-do, on building operational knowledge from the ground up. There are more than 300 examples and exhibits based on current market data. You will find essential information on: * The global money market * Foreign exchange transaction and foreign exchange derivatives * Bonds and zero coupon bonds - including a risk management-driven discussion of duration and convexity * Interest rate swaps, currency swaps, and exchange-traded futures * Stochastic models and option pricing * Stochastic models of the yield curve

Author Biography

<b>GIORGIO S. QUESTA</b> is a senior consultant at Pareto Partners, a quantitative institutional asset management firm with operations in the U.K., the U.S., and Australia. He teaches a number of graduate courses in finance, both in the U.S. and Europe. Previously, he was the CEO of IMI International, an investment banking and asset management firm with operations in New York, London, Frankfurt, and Luxembourg. He has also worked with Procter & Gamble and Andersen Consulting.

Table of Contents

Preface	x
Reader's Guide	xii
Acknowledgments	xvi
Part 1 Short-Term Money Market Instruments
Background and Terminology
Quotations, Bid-Ask Spread, and Transaction Costs	3	(4)
Trade, Settlement, and Maturity Dates. Accrual Rules	7	(4)
Long and Short Positions; Short Selling Securities	11	(4)
Arbitrage-Free Pricing and the Law of One Price	15	(3)
Euromarket Time Deposits and LIBOR Reference Rate	18	(2)
Short-Term Discount Securities	20	(3)
Auctions	23	(5)
Interest, Discount, and Compounded Yield
Interest Rate, Discount Rate, and Spot Yield	28	(4)
Compounding and Internal Rate of Return	32	(5)
U.S. Bond Yield Basis and the Treasury Method	37	(3)
Inflation and Real Yields	40	(3)
Yield Spreads on Short-Term Dollar Securities	43	(3)
The Exponential Notation
The Exponential Notation for Continuous Compounding	46	(2)
Period Return and Logs of Price Relatives	48	(4)
Convexity of the Log-Rate Function	52	(2)
Exponential Rate and Time Series	54	(2)
Mathematical Appendix	56	(3)
Spot and Forward Yields: FRAs, Repos, and Futures
Forwards: Arbitrage-Free Pricing and Credit Risk	59	(4)
Spot and Forward Yields	63	(7)
Forward Rate Agreements	70	(5)
Repos and Repo Rates	75	(5)
Futures	80	(4)
Futures on Short-Term Interest Rates	84	(2)
U.S. T-bill Futures and Cash-Futures Arbitrage	86	(4)
Mathematical Appendix	90	(4)
Foreign-Exchange Transactions
Spot Transactions, Cross Rates, and Arbitrage-Free Parties	94	(3)
Forward Transactions, Covered Interest Parity, and Basis Risk	97	(6)
Foreign Exchange (FX) Swaps	103	(2)
FX Futures	105	(1)
Hedging FX Risk and Cross-Currency Hedging	106	(5)
Settlement Risk (Herstatt Risk)	111	(4)
Part 2 Long-Term Securities, Futures, and Swaps
Zero-Coupon Bonds
The Development of Zero-Coupon Bonds	115	(3)
Price-Yield Relationship, Duration, and Convexity	118	(9)
Spot and Forward Yields	127	(4)
Hedging, Barbell Trades, and Spread over Benchmark	131	(3)
Horizon Yield, Expectations, and Risk Premium	134	(1)
Mathematical Appendix	135	(3)
Fixed-Interest Coupon Bonds
Introduction	138	(2)
Yield Analysis	140	(4)
Yield to Maturity: Operational Details	144	(4)
Yield Curve Pricing, Yield Spreads, and Par Yield Curve	148	(3)
Duration, Convexity, and Horizon Yield	151	(8)
Mathematical Appendix	159	(4)
Coupon Bonds: Advanced Topics
Simple Duration Pitfalls: The Orange County Case	163	(2)
Key Rate Duration	165	(1)
Callable Bonds, Sinking Fund Bonds, and Option-Adjusted Spread	166	(5)
Extracting the Spot Yield Curve from Coupon Bonds	171	(4)
Floating-Rate Securities
The Development of Floating-Rate Securities	175	(2)
Price, Yield, and Spread	177	(3)
Inverse Floaters and Floating Rate Perpetuities	180	(4)
Interest-Rate and Currency Swaps
Introduction	184	(1)
Interest-Rate Swaps: Pricing, Valuation, and Asset Swaps	185	(4)
Swaps and Comparative Advantage in Funding	189	(2)
Swap Dealers and Swap Warehousing	191	(2)
Currency Swaps	193	(3)
Credit Risk in Swaps	196	(3)
Futures on Bonds and Notes
U.S. T-bond Futures Analytics and the Cheapest-to-Deliver Bond	199	(6)
Hedging and Pricing	205	(1)
Other Important Bond Futures	206	(3)
Appendix	209	(4)
Part 3 Options
An Introduction to Options
Introduction	213	(3)
Standard Terminology	216	(3)
Payoff at Maturity of Puts and Calls	219	(2)
Time Value and Early Exercise of American Options	221	(3)
Payoff at Maturity of Options Strategies	224	(7)
Put-Call Parity and the Box	231	(5)
Butterfly Spread and Arrow Debreu Securities	236	(2)
Fixed-Income Options, Bonds with Optionlike Features
Exchange-Traded Options and Futures Options	238	(2)
Caps, Floors, Collars, and Swaptions	240	(2)
Mortgage-Backed Securities and Collateralized Mortgage Obligations	242	(6)
Basic Statistical Tools
Variance, Standard Deviation, and Expected Value	248	(4)
Extracting Volatilities from Time Series	252	(2)
The Binomial Distribution	254	(4)
The Normal Distribution	258	(2)
Normal Distribution and Time-Series Volatility	260	(2)
The Standard Normal Distribution	262	(3)
Mathematical Appendix	265	(3)
Stochastic Models
Introduction, Random Drawings from a Binomial Distribution	268	(1)
The Cox, Ross, and Rubinstein (CRR) Approach	269	(5)
The Symmetric Probabilities Implementation	274	(1)
Random Drawings from a Normal Distribution	275	(2)
The Lognormal Distribution	277	(4)
Tuning the Probability Structure of a CRR Binomial Tree	281	(3)
Binomial Option Pricing: An Introduction
Arbitrage-Free Option Pricing and Models of Stock Prices	284	(3)
The One-Step Binomial Model and Arbitrage-Free Pricing	287	(4)
Risk-Neutral Pricing	291	(1)
European Put Options	292	(4)
Extending the Binomial Model
Multistep Models	296	(2)
Early Exercise of American Puts	298	(4)
Dividends	302	(2)
Options on Foreign Exchange	304	(2)
Options on Futures	306	(3)
The Black-Scholes and Other Option-Pricing Models
The Black-Scholes Model	309	(4)
The Greek Letters	313	(5)
Implied Volatility; the Volatility Smile and Skew	318	(3)
Variations on the Black-Scholes Equation	321	(2)
Monte Carlo Simulation	323	(4)
Modeling the Yield Curve
Introduction	327	(3)
Arbitrage-Free Pricing	330	(5)
The Problem with Spot Yields Correlation	335	(2)
The Ho and Lee One-Factor Model	337	(2)
The Black, Derman, and Toy One-Factor Model	339	(3)
Mathematical Appendix	342	(3)
Selected Bibliography	345	(4)
Index	349