Fixed Income Markets and Their Derivatives (Academic Press Advanced Finance)

The 3e of this well-respected textbook continues the tradition of providing clear and concise explanations for fixed income securities, pricing, and markets. The book matches well with fixed income securities courses. The book's organization emphasizes institutions in the first part, analytics in the second, selected segments of fixed income markets in the third, and fixed income derivatives in the fourth. This enables instructors to customize the material to suit their course structure and the mathematical ability of their students. * New material on Credit Default Swaps, Collateralized Debt Obligations, and an intergrated discussion of the Credit Crisis have been added. *Online Resources for instructors on password protected website provides worked out examples for each chapter. * A detailed description of all key financial terms is provided in a glossary at the back of the book. Front Cover......Page 1 Fixed Income Markets and Their Derivatives......Page 6 Copyright Page......Page 7 Contents......Page 10 Preface......Page 18 Acknowledgments......Page 20 PART 1 INSTITUTIONS AND CONVENTIONS......Page 22 1.1 Overview of Debt Contracts......Page 24 1.1.1 Cash-Flow Rights of Debt Securities......Page 28 1.2 Players and Their Objectives......Page 29 1.2.3 Federal Agencies and Government-Sponsored Enterprises (GSEs)......Page 31 1.2.7 Households......Page 32 1.3 Classification of Debt Securities......Page 33 1.4.1 Interest Rate Risk......Page 35 1.4.2 Credit Risk......Page 36 1.4.3 Liquidity Risk......Page 37 1.4.4 Contractual Risk......Page 39 1.4.5 Inflation Risk......Page 40 1.4.8 FX Risk......Page 41 1.5 Return-Risk History......Page 42 Suggested References and Readings......Page 45 2.1.1 Future Values......Page 46 2.1.2 Annuities......Page 48 2.1.3 Present Values......Page 50 2.2. Yield to Maturity or Internal Rate of Return......Page 52 2.2.1 Semiannual Compounding......Page 53 2.3. Prices in Practice......Page 54 2.4. Prices and Yields of T-Bills......Page 55 2.4.1 Yield of a T-Bill with n 182 Days......Page 57 2.5. Prices and Yields of T-Notes and T-Bonds......Page 58 2.7. Conventions in Other Markets......Page 63 Suggested References and Readings......Page 65 3.1 Central Banks......Page 66 3.2.1 Open Market Operations......Page 67 3.2.2 The Discount Window......Page 69 3.2.3 Reserve Requirements......Page 70 3.3 Fed Funds Rates......Page 72 3.5 Fed's Actions to Stem the Credit Crunch of 2007–2008......Page 74 Suggested Readings and References......Page 77 4.1 Introduction......Page 78 4.2.2 Corporate Debt......Page 79 4.3 Interdealer Brokers......Page 80 4.4 Secondary Markets......Page 81 4.4.2 Indicators of Transparency......Page 82 4.4.3 Evidence on Trading Characteristics......Page 84 4.5 Evolution of Secondary Markets......Page 85 Suggested Readings and References......Page 87 5.1.1 Repo Contract Defined......Page 88 5.1.2 Reverse Repo Contract Defined......Page 90 5.2 Real-Life Features......Page 91 5.3 Long and Short Positions Using Repo and Reverse Repo......Page 95 5.4.1 GC Repo Contract and Market......Page 98 5.4.2 GC Repo Rates......Page 99 5.5 Special Collateral Repo Agreement......Page 103 5.7 Developments in Repo Markets......Page 105 Suggested Readings and References......Page 107 6.1 Benchmark Auctions Schedule......Page 108 6.1.2 Auctions of Treasury Notes......Page 110 6.1.4 Auctions of TIPS......Page 111 6.2.1 Auction Announcement......Page 112 6.2.3 Auction Mechanisms......Page 114 6.2.4 Uniform Price Auctions......Page 115 6.2.5 Discriminatory Auctions......Page 118 6.3.1 Winner's Curse and Bid Shading......Page 120 6.4 Auction Cycles and Financing Rates......Page 121 Suggested Readings and References......Page 122 PART 2 ANALYTICS OF FIXED INCOME MARKETS......Page 124 7.1 DV01/PVBP or Price Risk......Page 126 7.2 Duration......Page 130 7.2.1 Excel Applications......Page 134 7.2.3 PVBP and Duration of Portfolios......Page 137 7.3.1 Spread Trades: Curve Steepening or Curve Flattening Trades......Page 139 7.4 Convexity......Page 140 7.4.1 Bullet versus Barbell Securities (Butterfly Trade)......Page 143 7.5 Effective Duration and Effective Convexity......Page 146 Suggested Readings and References......Page 150 8.1 Yield-Curve Analysis......Page 152 8.1.1 Principal Components Analysis of Yield Curve......Page 156 8.1.2 Volatility of Short and Long Rates......Page 157 8.1.4 Economic News Announcements and Volatility......Page 159 8.1.6 Coupon and Vintage Effects......Page 161 8.2.1 Implied Zeroes......Page 164 8.2.2 Bootstrapping Procedure......Page 165 8.2.3 Par Bond Yield Curve......Page 171 8.3 Forward Rates of Interest......Page 172 8.4 STRIPS Markets......Page 176 8.5 Extracting Zeroes in Practice......Page 179 Suggested References and Readings......Page 184 9.1 Introduction......Page 186 9.2 Modeling Mean-Reverting Interest Rates......Page 193 9.2.1 The Vasicek Model......Page 196 9.2.2 The Cox, Ingersoll, and Ross Model......Page 199 9.3.1 The Black, Derman, and Toy Model......Page 201 9.3.2 General Implementation of the BDT Approach......Page 207 9.4 Interest Rate Derivatives......Page 209 9.5 A Review of One-Factor Models......Page 214 Suggested Readings and References......Page 216 10.1 Defaults, Business Cycles, and Recoveries......Page 218 10.2 Rating Agencies......Page 222 10.3 Structural Models of Default......Page 225 10.3.1 Probability of Default and Loss Given Default......Page 231 10.3.2 Market Prices......Page 233 10.4 Implementing Structural Models: The KMV Approach......Page 234 10.4.2 Safety Covenants......Page 237 10.5 Costs of Financial Distress and Corporate Debt Pricing......Page 238 10.6 Reduced-Form Models......Page 241 10.7 Credit Spreads Puzzle......Page 244 Suggested Readings and References......Page 245 PART 3 SOME FIXED INCOME MARKET SEGMENTS......Page 246 11.1 Overview of Mortgage Contracts......Page 248 11.1.1.1 Default Risk......Page 249 11.1.1.3 Interest Rate Risk......Page 250 11.2.1 Fixed-Rate Mortgages (FRMs)......Page 251 11.2.2 Adjustable-Rate Mortgages (ARMs)......Page 252 11.3 Mortgage Cash Flows and Yields......Page 254 11.4 Federal Agencies......Page 258 11.5 Federal Agency Debt Securities......Page 263 11.5.1 Empirical Evidence on Spreads......Page 264 Suggested Readings and References......Page 265 12.1 Overview of Mortgage-Backed Securities......Page 266 12.1.1 Securitization......Page 267 12.1.2 Guarantees and Credit Enhancement......Page 268 12.1.3 Creation of an Agency MBS......Page 270 12.1.4 Cash Flows and Market Conventions......Page 271 12.2.1.2 Constant Monthly Mortality......Page 272 12.2.2 FHA Experience......Page 273 12.2.3 PSA Experience......Page 274 12.2.4 Mortgage Cash Flows with Prepayments......Page 275 12.3.2 Seasonality Factor......Page 278 12.3.4 Family Circumstances......Page 279 12.3.6 Mortgage Status (Premium Burnout)......Page 280 12.4 Valuation Framework......Page 281 12.5 Valuation of Pass-Through MBS......Page 283 12.6 REMICS......Page 285 12.6.1 REMIC Structure......Page 286 12.6.2 Sequential Structure......Page 287 Suggested Readings and References......Page 288 13.1 Overview of Inflation-Indexed Debt......Page 290 13.2 Role of Indexed Debt......Page 294 13.3.1 Choice of Index......Page 296 13.3.2 Indexation Lag......Page 297 13.3.4 Strippability of TIPS......Page 298 13.4 Cash-Flow Structure......Page 299 13.4.2 Principal-Indexed Structure......Page 300 13.5 Real Yields, Nominal Yields, and Break-Even Inflation......Page 301 13.6 Cash Flows, Prices, Yields, and Risks of TIPS......Page 304 13.7 Investor's Perspective......Page 309 Suggested Readings and References......Page 311 PART 4 FIXED INCOME DERIVATIVES......Page 312 14.1 Overview......Page 314 14.2 Fed Funds Futures Contracts......Page 315 14.2.1 Recovering Market Expectations of Future Actions by the FOMC......Page 316 14.3.1 Contract Specifications......Page 318 14.4 Valuation of OIS......Page 320 14.5 OIS Spreads with Other Money Market Yields......Page 322 Suggested Readings and References......Page 323 15.1 Eurodollar Markets and LIBOR......Page 324 15.1.1 LIBOR Fixing......Page 325 15.1.2 Calculating Yields in the Cash Market......Page 326 15.2 Eurodollar Futures Markets and LIBOR......Page 327 15.2.1 Eurodollar Futures Settlement to Yields......Page 329 15.3 Deriving Swap Rates from ED Futures......Page 332 15.4 Intermarket Spreads......Page 336 15.5 Options on ED Futures......Page 337 15.5.1 Caps, Floors, and Collars on LIBOR......Page 338 15.6 Valuation of Caps......Page 342 Suggested Readings and References......Page 345 16.1 Swaps and Swap-Related Products and Terminology......Page 346 16.1.1 Asset Swaps......Page 347 16.1.2 Diversity of Swap Contracts......Page 348 16.2 Valuation of Swaps......Page 349 16.2.1 Forward Swap......Page 355 16.2.2 ED Futures and Swap Pricing......Page 357 16.2.3 Convexity Adjustment......Page 359 16.3 Swap Spreads......Page 360 16.3.1 Liquidity Factor or the Systemic Risk Factor......Page 364 16.3.3 Agency Activities......Page 365 16.4 Risk Management......Page 366 16.4.1 Management of the Credit Risk of Swaps......Page 367 16.5 Swap Bid Rate, Offer Rate, and Bid-Offer Spreads......Page 368 16.6 Swaptions......Page 369 16.6.1 Swaption Parity Relation......Page 372 Suggested Readings and References......Page 373 17.1 Forward Contracts Defined......Page 374 17.2 Futures Contracts Defined......Page 376 17.3.1 Delivery Specifications......Page 378 17.3.3 Margins......Page 379 17.5 Treasury Futures Contracts......Page 380 17.5.1 Delivery Options in Treasury Note Futures......Page 381 17.5.2 Conversion Factor......Page 384 17.5.3 Seller's Option in the September 2007 Contract......Page 385 17.5.3.1 Basis in T-Bond Futures......Page 386 17.5.4 Determination of Delivery......Page 387 17.5.5 Basis after Carry, or Net Basis......Page 390 17.5.6 Implied Repo Rate......Page 391 17.5.8 Hedging Applications......Page 394 Suggested Readings and References......Page 396 18.1 Credit Default Swaps......Page 398 18.3 Growth of CDS Market and Evolution......Page 401 18.4 Restructuring and Deliverables......Page 403 18.5 Settlement on Credit Events......Page 405 18.6 Valuation of CDS......Page 407 18.6.1 CDS Spreads, Probability of Default, and Recovery Rates......Page 409 18.6.2 Applications......Page 412 18.7 Credit-Linked Notes......Page 414 18.8 Credit Default Indexes......Page 415 Suggested Readings and References......Page 417 CHAPTER 19 Structured Credit Products: Collateralized Debt Obligations......Page 418 19.1 Collateralized Debt Obligations......Page 419 19.1.1 CDO Structure and Players......Page 420 19.1.2 Types of Cash CDOs......Page 421 19.2 Analysis of CDO Structure......Page 422 19.2.2 Extent of Subordination, Overcollateralization, and Waterfalls......Page 423 19.3 Growth of the CDO Market......Page 425 19.5 CDX Tranches......Page 426 19.6 Valuation of CDOs......Page 428 Suggested Readings and References......Page 431 B......Page 432 C......Page 433 D......Page 434 F......Page 435 I......Page 436 M......Page 437 P......Page 438 S......Page 439 U......Page 441 Z......Page 442 C......Page 444 D......Page 446 F......Page 447 I......Page 449 M......Page 450 P......Page 451 R......Page 452 S......Page 453 T......Page 454 V......Page 455 Z......Page 456 The third edition of this well-respected textbook continues the tradition of providing clear and concise explanations for fixed income securities, pricing, and markets. Fixed Income Markets and Their Derivatives matches well with fixed income securities courses. The book's organization emphasizes institutions in the first part, analytics in the second, selected segments of fixed income markets in the third, and fixed income derivatives in the fourth. This enables instructors to customize the material to suit their course structure and the mathematical ability of their students. New material on Credit Default Swaps, Collateralized Debt Obligations, and an intergrated discussion of the Credit Crisis have been added Online Resources for instructors on password protected website provides worked out examples for each chapter A detailed description of all key financial terms is provided in a glossary at the back of the book The 3e of this well-respected textbook continues the tradition of providing clear and concise explanations for fixed income securities, pricing, and markets. The book matches well with fixed income securities courses. The book's organization emphasizes institutions in the first part, analytics in the second, selected segments of fixed income markets in the third, and fixed income derivatives in the fourth. This enables instructors to customize the material to suit their course structure and the mathematical ability of their students.

* New material on Credit Default Swaps, Collateralized Debt Obligations, and an intergrated discussion of the Credit Crisis have been added.
*Online Resources for instructors on password protected website provides worked out examples for each chapter.
* A detailed description of all key financial terms is provided in a glossary at the back of the book.