Fixed Income Securities: Valuation, Risk, and Risk Management

PREFACE

It is now the middle of 2009 and finally this book is completed. It has been very exciting to write a text on the risk and return of fixed income securities, and their derivatives, in the middle of what many consider the biggest financial crisis since the Great Depression. In these three years of work the world of finance changed, as many key players in fixed income markets either collapsed (e.g., the investment banks Bears Stearns and Lehman Brothers), have been acquired by the U.S. government (e.g., the two mortgage giant agencies Freddie Mac and Fannie Mae), or have been acquired by other banks (e.g., the investment bank Merrill Lynch). In this turmoil, the U.S. government has taken the center stage: On the one hand, the Federal Reserve decreased its reference short-term interest rate, the Federal Funds target rate, to almost zero, and acted swiftly to set up lending facilities to provide liquidity to the financial system. On the other hand, the U.S. Treasury used Congress-approved funds to bail out a number of financial institutions, while the Federal Deposit Insurance Corporation (FDIC) extended guarantees on the short-term debt of banks in risk of default.

What will this financial turmoil do to fixed income markets around the world?

While it is still hard to forecast how long the recession will last, a certain fact for now is that fixed income markets will get bigger. And this for several reasons: First, governments’ debt will expand in the future, as governments ...