Interest Rate Markets : A Practical Approach to Fixed Income

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  • Edition: 1st
  • Format: Hardcover
  • Copyright: 2011-04-05
  • Publisher: Wiley
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The interest rate market is a marketplace for the allocation of trillions of dollars from savers to borrowers and institutions of all sizes and types participate in the market. As other fixed income markets have grown over the past two decades, managing interest rate risk inherent in almost any fixed income instrument has become a crucial task even for portfolio managers not in interest rate markets directly.The book discusses the typical quantitative tools used to analyze rates markets such as regression, looks at the range of fixed income markets on the cash side, analyzes interest rate movements, and delves into derivatives side of the business. Beyond just mechanics of products, the markets themselves are discussed including fundamental drivers of interest rates and interest rate volatility. Fundamentals are only one piece of the puzzle and the chapters also discuss the main players in the rates markets, their motivations, and how to spot changing behavior to stay ahead of the curve. The key takeaways from these chapters is to understand the structural nature of the rates markets and develop a framework for thinking about these markets intuitively rather than just focusing on the setup of the markets currently, which is liable to change.To summarize, the focus of the book will be on the following ideas: quantitative tools which are useful in financial markets mechanics of interest rate products, both cash bonds and derivatives including swaps, options, and futures thought processes for forming a view on interest rates and related variables such as swap spreads types of trades commonly done by professionals in the market to express views and detailed discussions of methods to accurately set up the trades emphasizing the importance of hedging and quantitatively managing risks inherent in interest rate trades common pitfalls and risks facing interest rate trades especially examples from market breakdowns in 2008.

Author Biography

Siddhartha Jha is a Senior Analyst with Arrowhawk Capital Partners. Previously, as part of J. P. Morgan's Fixed Income Strategy Team, he covered a wide range of rates markets—from municipals to liquid products including Treasuries, swaps, futures, and options—analyzing macroeconomic trends as well as short-term technical factors. He spent five years there developing trade ideas, building quantitative models, and discussing market trends with institutional investors. He graduated cum laude with a dual bachelor's and master's in applied mathematics and statistics from Harvard University.

Table of Contents

Acknowledgmentsp. xiii
Introductionp. xv
Tools of the Tradep. 1
Basic Statisticsp. 2
Regression: The Fundamentalsp. 6
Regression: How Good a Fit?p. 11
Principal Components Analysisp. 14
Scaling through Timep. 15
Backtesting Strategiesp. 16
Summaryp. 17
Bondsp. 19
Basics of Bondsp. 19
Risks Embedded in Fixed Income Instrumentsp. 22
Discountingp. 27
Bond Pricingp. 28
Yield Curvep. 32
Durationp. 34
Convexityp. 37
Repo Marketsp. 42
Bid Offerp. 44
Calculating Profit/Loss of a Bondp. 45
Carryp. 45
Forward Ratesp. 47
Rolldown/Slidep. 51
Curves and Spreadsp. 53
Butterfly Tradesp. 55
Summaryp. 56
Fixed Income Marketsp. 59
Federal Reservep. 60
Treasuriesp. 67
TIPSp. 71
Mortgagesp. 73
Agency Debtp. 77
Corporate Bondsp. 79
Municipal Bondsp. 82
Summaryp. 84
Interest Rate Futuresp. 85
Basics of Futures Transactionsp. 86
Eurodollar Futuresp. 89
Convexity (or Financing) Biasp. 92
Creating Longer-Dated Assets Using Eurodollar Futuresp. 93
Treasury Futuresp. 94
Fed Funds Futuresp. 101
Futures Positioning Datap. 104
Summaryp. 105
Interest Rate Swapsp. 107
Basic Principlesp. 108
Duration and Convexityp. 111
Uses of Swapsp. 112
Counterparty Riskp. 115
Other Types of Swapsp. 115
Summaryp. 124
Understanding Drivers of Interest Ratesp. 125
Supply and Demand for Borrowingp. 126
Components of Fixed Income Supply and Demandp. 141
Treasury Supplyp. 141
Other Sources of Fixed Income Supplyp. 145
Fixed Income Demandp. 148
Short-Term Yield Driversp. 157
Summaryp. 172
Carry and Relative Value Tradesp. 173
Carry Tradesp. 173
Carry Trade Setup and Evaluationp. 175
Pitfalls of the Carry Tradep. 178
Carry-Efficient Directional Tradesp. 182
Relative Value Tradesp. 183
Setting Up Relative Value Tradesp. 185
Treasury Bond Relative Value-Par Curvep. 191
Other Treasury Relative Value Tradesp. 193
Summaryp. 194
Hedging Risks in Interest Rate Productsp. 197
Principles of Hedgingp. 198
Choices of Instruments for Hedgingp. 202
Calculating Hedge Ratiosp. 210
Yield Betasp. 215
Convexity Hedgingp. 218
Summaryp. 223
Trading Swap Spreadsp. 225
How Swap Spreads Workp. 225
Why Trade Swap Spreads?p. 230
Directionality of Swap Spreads to Yieldsp. 240
Futures Asset Swapsp. 241
Spread Curve Tradesp. 243
Summaryp. 245
Interest Rate Options and Trading Volatilityp. 247
Option Pricing and Fundamentalsp. 249
Modifications for the Interest Rate Marketsp. 254
Quoting Volatilityp. 256
Measuring Risks in Option Positionsp. 257
Put/Call Parityp. 266
Implied and Realized Volatilityp. 268
Skewp. 270
Delta Hedgingp. 270
Interest Rate Optionsp. 275
Embedded Options and Hedgingp. 280
More Exotic Structuresp. 283
Yield Curve Spread Optionsp. 284
Forward Volatilityp. 285
Volatility Tradingp. 286
Interest Rate Skewp. 293
Volatility Spread Tradesp. 294
Caps versus Swaptionsp. 297
Summaryp. 298
Treasury Futures Basis and Rollsp. 299
The Futures Delivery Optionp. 299
Calculating the Delivery Option Valuep. 309
Option-Adjusted and Empirical Durationp. 311
Treasury Futures Rollsp. 313
Summaryp. 318
Conditional Tradesp. 319
Conditional Curve Tradesp. 320
Conditional Spread Tradesp. 324
Summaryp. 328
Referencesp. 329
About the Authorp. 331
About the Web Sitep. 333
Indexp. 335
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