Fixed-Income Securities and Derivatives Handbook Analysis and Valuation

by Choudhry, Moorad

• ISBN13: 9781576603345
• ISBN10: 1576603342
• Edition: 2nd
• Format: Hardcover
• Copyright: 2010-08-02
• Publisher: Bloomberg Press

Summary

regulatory changes, volatile markets, incalculable valuations, mark-to-market accounting - these are just a few of the dramatic changes to have occured since the credit crash of 2008. but where do traders, money managers and institutional investors go for comprehensive analysis of the most recent revolutions in the fixed-income market? in thisi fully updated and expanded post-crash edition of the fixed-income securities and derivatives handbook, moorad choudhry explains the new regulatory twists, the evolving derivatives market, as well as new instruments and opportunities in the bond market. a mix of practical tips and academic theory, this second edition includes new material on covered bonds, credit derivatives, convertible bonds, swaps, synthetic securitization, bond portfolio management and more.

Author Biography

Moorad Choudhry is head of Treasury at KBC Financial Products in London, in addition to serving as visiting professor in the Department of Economics at London Metropolitan University. He has written extensively about the fixed-income market, most recently in his book The Credit Default Swap Basis (Bloomberg Press, 2006).

Table of Contents

Foreword	p. xv
Preface	p. xvii
Introduction to Bonds
The Bond Instrument	p. 3
The Time Value of Money	p. 4
Basic Features and Definitions	p. 5
Present Value and Discounting	p. 6
Discount Factors	p. 12
Bond Pricing and Yield: The Traditional Approach	p. 15
Bond Pricing	p. 16
Bond Yield	p. 20
Floating Rate Notes	p. 27
Accrued Interest	p. 30
Clean and Dirty Bond Prices	p. 30
Day-Count Conventions	p. 32
Bond Instruments and Interest Rate Risk	p. 35
Duration, Modified Duration, and Convexity	p. 35
Duration	p. 36
Properties of Macaulay Duration	p. 40
Modified Duration	p. 41
Convexity	p. 45
Bond Pricing and Spot and Forward Rates	p. 51
Zero-Coupon Bonds	p. 51
Coupon Bonds	p. 53
Bond Price in Continuous Time	p. 55
Fundamental Concepts	p. 55
Stochastic Rates	p. 58
Coupon Bonds	p. 60
Forward Rates	p. 61
Guaranteeing a Forward Rate	p. 61
The Spot and Forward Yield Curve	p. 63
Calculating Spot Rates	p. 64
Term Structure Hypotheses	p. 67
The Expectations Hypothesis	p. 67
Liquidiry Premium Hypothesis	p. 69
Segmented Markets Hypothesis	p. 69
Interest Rate Modeling	p. 71
Basic Concepts	p. 71
Shore-Rare Processes	p. 72
Ico's Lemma	p. 74
One-Factor Term-Structure Models	p. 75
Vasicek Model	p. 75
Hull-White Model	p. 76
Further One-Factor Term-Structure Models	p. 77
Cox-Ingersoll-Ross (CIR) Model	p. 78
Two-Factor Interest Rate Models	p. 79
Brennan-Schwartz Model	p. 80
Extended Cox-Ingersoll-Ross Model	p. 80
Heath-Jarrow-Morton (HJM) Model	p. 81
The Multifactor HJM Model	p. 82
Choosing a Term-Structure Model	p. 83
Fitting the Yield Curve	p. 87
Yield Curve Smoothing	p. 88
Smoothing Techniques	p. 90
Cubic Polynomials	p. 91
Non-Parametric Methods	p. 92
Spline-Based Methods	p. 92
Nelson and Siegel Curves	p. 95
Comparing Curves	p. 96
Fitting the Term Structure of Interest Rates: The Practical Implementation of Cubic Spline Methodology	p. 96
Cubic Spline Methodology	p. 97
The Hypothesis	p. 99
Practical Approach	p. 100
A Working Environment	p. 100
The First Requirement	p. 101
The Second Requirement	p. 101
The Third Requirement	p. 102
Meeting All Requirements Simultaneously	p. 102
A Unique Solution	p. 103
The Solution	p. 108
A Look at Forward Rates	p. 114
Conclusion	p. 117
Selected Cash and Derivative Instruments
Forwards and Futures Valuation	p. 121
Forwards and Futures	p. 121
Cash Flow Differences	p. 122
Relationship between Forward and Futures Prices	p. 124
Forward-Spot Parity	p. 125
The Basis and Implied Repo Rate	p. 127
Swaps	p. 131
Interest Rare Swaps	p. 132
Market Terminology	p. 134
Swap Spreads and the Swap Yield Curve	p. 135
Generic Swap Valuation	p. 138
Intuitive Swap Pricing	p. 138
Zero-Coupon Swap Valuation	p. 139
Calculating the Forward Rate from Spot-Rate Discount Factors	p. 139
The Key Principles of an Interest Rate Swap	p. 143
Valuation Using the Final Maturity Discount Factor	p. 143
Non-Plain Vanilla Interest Rate Swaps	p. 146
Swaptions	p. 148
Valuation	p. 149
Interest Rate Swap Applications	p. 150
Corporate and Investor Applications	p. 150
Hedging Bond Instruments Using Interest Rate Swaps	p. 153
Options	p. 157
Option Basics	p. 158
Terminology	p. 160
Option Instruments	p. 162
Option Pricing: Setting the Scene	p. 164
Limits on Option Prices	p. 165
Option Pricing	p. 166
The Black-Scholes Option Model	p. 168
Assumptions	p. 169
Pricing Derivative Instruments Using the Black-Scholes Model	p. 170
Put-Call Parity	p. 173
Pricing Options on Bonds Using the Black-Scholes Model	p. 174
Interest Rate Options and the Black Model	p. 174
Comments on the Black-Scholes Model	p. 180
Stochastic Volatility	p. 180
Implied Volatility	p. 180
Other Option Models	p. 181
Measuring Option Risk	p. 183
Option Price Behavior	p. 183
Assessing Time Value	p. 183
American Options	p. 184
The Greeks	p. 185
Delta	p. 185
Gamma	p. 187
Theta	p. 189
Vega	p. 189
Rho	p. 190
Lamda	p. 192
The Option Smile	p. 193
Caps and Floors	p. 194
Credit Derivatives	p. 197
Credit Risk	p. 198
Credit Risk and Credit Derivatives	p. 200
Applications of Credit Derivatives	p. 201
Credit Derivative Instruments	p. 202
Credit Default Swap	p. 202
Credit Options	p. 203
Credit-Linked Notes	p. 204
Total Return Swaps	p. 205
Investment Applications	p. 207
Capital Structure Arbitrage	p. 209
Exposure to Market Sectors	p. 210
Credit Spreads	p. 210
Funding Positions	p. 210
Credit Derivatives and Relative Value Trading	p. 212
Relative Value Trading Straregies	p. 212
Bond Valuation from CDS Prices: Bloomberg Screen VCDS	p. 217
Credit-Derivative Pricing	p. 218
Pricing Total Return Swaps	p. 218
Asset-Swap Pricing	p. 219
Credit-Spread Pricing Models	p. 219
The Market Approach to CDS Pricing	p. 220
Default Probabilities	p. 220
Pricing a CDS Contract	p. 226
Example Calculation	p. 228
The ITraxx and CD-X Credit Indices Contracts	p. 229
Index Tranche Market	p. 236
Impact of the 2007-2008 Credit Crunch: New CDS Contracts	p. 240
The Analysis of Bonds with Embedded Options	p. 245
Understanding Option Elements Embedded in a Bond	p. 245
Basic Options Features	p. 246
Option Valuation	p. 247
The Call Provision	p. 248
The Binomial Tree of Short-Term Interest Rates	p. 249
Arbitrage-Free Pricing	p. 250
Options Pricing	p. 252
Risk-Neutral Pricing	p. 254
Recombining and Nonrecombining Trees	p. 255
Pricing Callable Bonds	p. 256
Price and Yield Sensitivity	p. 261
Measuring Bond Yield Spreads	p. 263
Option-Adjusted Spread Analysis	p. 265
Introduction	p. 265
A Theoretical Framework	p. 266
The Methodology in Practice	p. 272
Convertible Bonds	p. 277
Basic Features	p. 277
Trading Patterns of Convertible Bonds	p. 279
Investor Analysis	p. 280
Zero-Coupon Convertibles	p. 284
Convertible Bond Default Risk	p. 285
Advantages of Issuing and Holding Convertibles	p. 285
Convertible Bond Valuation	p. 288
Fair Value of a Convertible Bond: The Binomial Model	p. 288
Model Parameters	p. 297
Pricing Spreadsheet	p. 299
Inflation-Indexed Bonds	p. 303
Basic Concepts	p. 303
Choice of Index	p. 303
Indexation Lag	p. 305
Coupon Frequency	p. 306
Type of Indexation	p. 306
Index-Linked Bond Cash Flows and Yields	p. 308
TIPS Cash Flow Calculations	p. 309
TIPS Price and Yield Calculations	p. 309
Assessing Yields on Index-Linked Bonds	p. 313
Which to Hold: Indexed or Conventional Bonds?	p. 314
Analysis of Real Interest Rates	p. 315
Indexation Lags and Inflation Expectations	p. 315
An Inflation Term Structure	p. 317
Inflation-Indexed Derivatives	p. 318
Securitization and Asset-Backed Securities	p. 327
The Concept of Securitization	p. 328
Reasons for Undertaking Securitization	p. 328
Benefits of Securitization to Investors	p. 330
The Process of Securitization	p. 331
Securitization Process	p. 331
Credit Enhancement	p. 335
Securirizing Mortgages	p. 336
Growth of the Market	p. 337
Mortgage Bond Risk	p. 338
Types of Mortgage-Backed Securities	p. 338
Cash Flow Patterns	p. 339
Prepayment Analysis	p. 340
Prepayment Models	p. 344
ABS Structures: A Primer on Performance Metrics and Test Measures	p. 345
Collateral Types	p. 345
Summary of Performance Metrics	p. 351
Securitization: Features of the 2007-2009 Financial Crisis	p. 351
Impact of the Credit Crunch	p. 351
Collateralized Debt Obligations	p. 357
CDO Structures	p. 359
Conventional CDO Structures	p. 359
Synthetic CDO Structures	p. 360
Motivation Behind CDO Issuance	p. 362
Balance Sheet-Driven Transactions	p. 362
Investor-Driven Arbitrage Transactions	p. 363
Analysis and Evaluation	p. 363
Portfolio Characteristics	p. 363
Cash Flow Analysis and Stress Testing	p. 364
Originator's Credit Quality	p. 365
Operational Aspects	p. 365
Legal Structure of the Transaction	p. 365
Expected Loss	p. 366
CDO Market Overview Since 2005	p. 366
Risk and Capital Management	p. 368
Selected Market Trading Considerations
The Yield Curve, Bond Yield, and Spot Rates	p. 373
Practical Uses of Redemption Yield and Duration	p. 373
The Concept of Yield	p. 374
Yield Comparisons in the Market	p. 376
Measuring a Bond's True Return	p. 376
Illustrating Bond Yield Using a Microsoft Excel Spreadsheet	p. 380
Implied Spot Rates and Market Zero-Coupon Yields	p. 388
Spot Yields and Coupon-Bond Prices	p. 389
Implied Spot Yields and Zero-Coupon Bond Yields	p. 393
Determining Strip Values	p. 394
Strips Market Anomalies	p. 395
Strips Trading Strategy	p. 396
Case Study: Treasury Strip Yields and Cash Flow Analysis	p. 399
Approaches to Trading	p. 401
Futures Trading	p. 402
Yield Curves and Relative Value	p. 406
Determinants of Government Bond Yields	p. 406
Characterizing the Complete Term Structure	p. 408
Identifying Relative Value in Government Bonds	p. 409
Hedging Bond Positions	p. 412
Simple Hedging Approaches	p. 412
Hedge Analysis	p. 413
Summary of the Derivation of the Optimum-Hedge Equation	p. 415
Credit Analysis and Relative Value Measurement	p. 417
Credit Ratings	p. 418
Purpose of Credit Ratings	p. 418
Formal Credit Ratings	p. 419
Credit Analysis	p. 420
The Issuer Indusrry	p. 421
Financial Analysis	p. 423
Industry-Specific Analysis	p. 426
Utility Companies	p. 426
Financial Sector Companies	p. 427
The Art of Credit Analysis	p. 428
Bond Spreads and Relative Value	p. 429
Bond Spreads	p. 429
Summary of Fund Managers' Approach to Value Creation	p. 438
The Black-Scholes Model in Microsoft Excel	p. 443
Iterative Formula Spreadsheet	p. 445
Pricing Spreadsheet	p. 447
References	p. 451
About the Author	p. 463
Index	p. 465
Table of Contents provided by Ingram. All Rights Reserved.

Supplemental Materials

What is included with this book?

The New copy of this book will include any supplemental materials advertised. Please check the title of the book to determine if it should include any access cards, study guides, lab manuals, CDs, etc.

The Used, Rental and eBook copies of this book are not guaranteed to include any supplemental materials. Typically, only the book itself is included. This is true even if the title states it includes any access cards, study guides, lab manuals, CDs, etc.

Rewards Program

Currently unavailable