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BOND MATH: The Theory Behind the Formulas

Book Description

A guide to the theory behind bond math formulas

Bond Math explores the ideas and assumptions behind commonly used statistics on risk and return for individual bonds and on fixed income portfolios. But this book is much more than a series of formulas and calculations; the emphasis is on how to think about and use bond math.

Author Donald J. Smith, a professor at Boston University and an experienced executive trainer, covers in detail money market rates, periodicity conversions, bond yields to maturity and horizon yields, the implied probability of default, after-tax rates of return, implied forward and spot rates, and duration and convexity. These calculations are used on traditional fixed-rate and zero-coupon bonds, as well as floating-rate notes, inflation-indexed securities, and interest rate swaps.

  • Puts bond math in perspective through discussions of bond portfolios and investment strategies.

  • Critiques the Bloomberg Yield Analysis (YA) page, indicating which numbers provide reliable information for making decisions about bonds, which are meaningless data, and which can be very misleading to investors

  • Filled with thought-provoking insights and practical advice, this book puts the intricacies of bond math into a clear and logical order.

Table of Contents

  1. Cover Page
  2. Title Page
  3. Copyright
  4. Dedication
  5. Contents
  6. Preface
  7. CHAPTER 1: Money Market Interest Rates
    1. Interest Rates in Textbook Theory
    2. Money Market Add-on Rates
    3. Money Market Discount Rates
    4. Two Cash Flows, Many Money Market Rates
    5. A History Lesson on Money Market Certificates
    6. Periodicity Conversions
    7. Treasury Bill Auction Results
    8. The Future: Hourly Interest Rates?
    9. Conclusion
  8. CHAPTER 2: Zero-Coupon Bonds
    1. The Story of TIGRS, CATS, LIONS, and STRIPS
    2. Yields to Maturity on Zero-Coupon Bonds
    3. Horizon Yields and Holding-Period Rates of Return
    4. Changes in Bond Prices and Yields
    5. Credit Spreads and the Implied Probability of Default
    6. Conclusion
  9. CHAPTER 3: Prices and Yields on Coupon Bonds
    1. Market Demand and Supply
    2. Bond Prices and Yields to Maturity in a World of No Arbitrage
    3. Some Other Yield Statistics
    4. Horizon Yields
    5. Some Uses of Yield-to-Maturity Statistics
    6. Implied Probability of Default on Coupon Bonds
    7. Bond Pricing between Coupon Dates
    8. A Real Corporate Bond
    9. Conclusion
  10. CHAPTER 4: Bond Taxation
    1. Basic Bond Taxation
    2. Market Discount Bonds
    3. A Real Market Discount Corporate Bond
    4. Premium Bonds
    5. Original Issue Discount Bonds
    6. Municipal Bonds
    7. Conclusion
  11. CHAPTER 5: Yield Curves
    1. An Intuitive Forward Curve
    2. Classic Theories of the Term Structure of Interest Rates
    3. Accurate Implied Forward Rates
    4. Money Market Implied Forward Rates
    5. Calculating and Using Implied Spot (Zero-Coupon) Rates
    6. More Applications for the Implied Spot and Forward Curves
    7. Conclusion
  12. CHAPTER 6: Duration and Convexity
    1. Yield Duration and Convexity Relationships
    2. Yield Duration
    3. The Relationship between Yield Duration and Maturity
    4. Yield Convexity
    5. Bloomberg Yield Duration and Convexity
    6. Curve Duration and Convexity
    7. Conclusion
  13. CHAPTER 7: Floaters and Linkers
    1. Floating-Rate Notes in General
    2. A Simple Floater Valuation Model
    3. An Actual Floater
    4. Inflation-Indexed Bonds: C-Linkers and P-Linkers
    5. Linker Taxation
    6. Linker Duration
    7. Conclusion
  14. CHAPTER 8: Interest Rate Swaps
    1. Pricing an Interest Rate Swap
    2. Interest Rate Forwards and Futures
    3. Inferring the Forward Curve
    4. Valuing an Interest Rate Swap
    5. Interest Rate Swap Duration and Convexity
    6. Conclusion
  15. CHAPTER 9: Bond Portfolios
    1. Bond Portfolio Statistics in Theory
    2. Bond Portfolio Statistics in Practice
    3. A Real Bond Portfolio
    4. Thoughts on Bond Portfolio Statistics
    5. Conclusion
  16. CHAPTER 10: Bond Strategies
    1. Acting on a Rate View
    2. An Interest Rate Swap Overlay Strategy
    3. Classic Immunization Theory
    4. Immunization Implementation Issues
    5. Liability-Driven Investing
    6. Closing Thoughts: Target-Duration Bond Funds
  17. Technical Appendix
    1. Chapter 1 : Money Market Interest Rates
    2. Chapter 3 : Prices and Yields on Coupon Bonds
    3. Chapter 6 : Duration and Convexity
    4. Chapter 7 : Floaters and Linkers
    5. Chapter 9 : Bond Portfolios
  18. Acronyms
  19. Bibliographic Notes
    1. Chapter 1 : Money Market Interest Rates
    2. Chapter 2 : Zero-Coupon Bonds
    3. Chapter 3 : Prices and Yields on Coupon Bonds
    4. Chapter 4 : Bond Taxation
    5. Chapter 5 : Yield Curves
    6. Chapter 6 : Duration and Convexity
    7. Chapter 7 : Floaters and Linkers
    8. Chapter 8 : Interest Rate Swaps
    9. Chapter 9 : Bond Portfolios
    10. Chapter 10 : Bond Strategies
  20. About the Author
  21. Acknowledgments
  22. Index