Interest Rate Markets A Practical Approach to Fixed Income

by Jha, Siddhartha

• ISBN13: 9780470932209
• ISBN10: 0470932201
• Edition: 1st
• Format: Hardcover
• Copyright: 2011-03-28
• Publisher: Wiley

Summary

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

Acknowledgments	p. xiii
Introduction	p. xv
Tools of the Trade	p. 1
Basic Statistics	p. 2
Regression: The Fundamentals	p. 6
Regression: How Good a Fit?	p. 11
Principal Components Analysis	p. 14
Scaling through Time	p. 15
Backtesting Strategies	p. 16
Summary	p. 17
Bonds	p. 19
Basics of Bonds	p. 19
Risks Embedded in Fixed Income Instruments	p. 22
Discounting	p. 27
Bond Pricing	p. 28
Yield Curve	p. 32
Duration	p. 34
Convexity	p. 37
Repo Markets	p. 42
Bid Offer	p. 44
Calculating Profit/Loss of a Bond	p. 45
Carry	p. 45
Forward Rates	p. 47
Rolldown/Slide	p. 51
Curves and Spreads	p. 53
Butterfly Trades	p. 55
Summary	p. 56
Fixed Income Markets	p. 59
Federal Reserve	p. 60
Treasuries	p. 67
STRIPS	p. 70
TIPS	p. 71
Mortgages	p. 73
Agency Debt	p. 77
Corporate Bonds	p. 79
Municipal Bonds	p. 82
Summary	p. 84
Interest Rate Futures	p. 85
Basics of Futures Transactions	p. 86
Eurodollar Futures	p. 89
Convexity (or Financing) Bias	p. 92
Creating Longer-Dated Assets Using Eurodollar Futures	p. 93
Treasury Futures	p. 94
Fed Funds Futures	p. 101
Futures Positioning Data	p. 104
Summary	p. 105
Interest Rate Swaps	p. 107
Basic Principles	p. 108
Duration and Convexity	p. 111
Uses of Swaps	p. 112
Counterparty Risk	p. 115
Other Types of Swaps	p. 115
Summary	p. 124
Understanding Drivers of Interest Rates	p. 125
Supply and Demand for Borrowing	p. 126
Components of Fixed Income Supply and Demand	p. 141
Treasury Supply	p. 141
Other Sources of Fixed Income Supply	p. 145
Fixed Income Demand	p. 148
Short-Term Yield Drivers	p. 157
Summary	p. 172
Carry and Relative Value Trades	p. 173
Carry Trades	p. 173
Carry Trade Setup and Evaluation	p. 175
Pitfalls of the Carry Trade	p. 178
Carry-Efficient Directional Trades	p. 182
Relative Value Trades	p. 183
Setting Up Relative Value Trades	p. 185
Treasury Bond Relative Value-Par Curve	p. 191
Other Treasury Relative Value Trades	p. 193
Summary	p. 194
Hedging Risks in Interest Rate Products	p. 197
Principles of Hedging	p. 198
Choices of Instruments for Hedging	p. 202
Calculating Hedge Ratios	p. 210
Yield Betas	p. 215
Convexity Hedging	p. 218
Summary	p. 223
Trading Swap Spreads	p. 225
How Swap Spreads Work	p. 225
Why Trade Swap Spreads?	p. 230
Directionality of Swap Spreads to Yields	p. 240
Futures Asset Swaps	p. 241
Spread Curve Trades	p. 243
Summary	p. 245
Interest Rate Options and Trading Volatility	p. 247
Option Pricing and Fundamentals	p. 249
Modifications for the Interest Rate Markets	p. 254
Quoting Volatility	p. 256
Measuring Risks in Option Positions	p. 257
Put/Call Parity	p. 266
Implied and Realized Volatility	p. 268
Skew	p. 270
Delta Hedging	p. 270
Interest Rate Options	p. 275
Embedded Options and Hedging	p. 280
More Exotic Structures	p. 283
Yield Curve Spread Options	p. 284
Forward Volatility	p. 285
Volatility Trading	p. 286
Interest Rate Skew	p. 293
Volatility Spread Trades	p. 294
Caps versus Swaptions	p. 297
Summary	p. 298
Treasury Futures Basis and Rolls	p. 299
The Futures Delivery Option	p. 299
Calculating the Delivery Option Value	p. 309
Option-Adjusted and Empirical Duration	p. 311
Treasury Futures Rolls	p. 313
Summary	p. 318
Conditional Trades	p. 319
Conditional Curve Trades	p. 320
Conditional Spread Trades	p. 324
Summary	p. 328
References	p. 329
About the Author	p. 331
About the Web Site	p. 333
Index	p. 335
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