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Fixed Income Securities: Tools for Today's Markets, 3rd Edition

Book Description

Fixed income practitioners need to understand the conceptual frameworks of their field; to master its quantitative tool-kit; and to be well-versed in its cash-flow and pricing conventions. Fixed Income Securities, Third Edition by Bruce Tuckman and Angel Serrat is designed to balance these three objectives. The book presents theory without unnecessary abstraction; quantitative techniques with a minimum of mathematics; and conventions at a useful level of detail.

The book begins with an overview of global fixed income markets and continues with the fundamentals, namely, arbitrage pricing, interest rates, risk metrics, and term structure models to price contingent claims. Subsequent chapters cover individual markets and securities: repo, rate and bond forwards and futures, interest rate and basis swaps, credit markets, fixed income options, and mortgage-backed-securities.

Fixed Income Securities, Third Edition is full of examples, applications, and case studies. Practically every quantitative concept is illustrated through real market data. This practice-oriented approach makes the book particularly useful for the working professional.

This third edition is a considerable revision and expansion of the second. Most examples have been updated. The chapters on fixed income options and mortgage-backed securities have been considerably expanded to include a broader range of securities and valuation methodologies. Also, three new chapters have been added: the global overview of fixed income markets; a chapter on corporate bonds and credit default swaps; and a chapter on discounting with bases, which is the foundation for the relatively recent practice of discounting swap cash flows with curves based on money market rates.

[FOR THE UNIVERSITY EDITION]

This university edition includes problems which students can use to test and enhance their understanding of the text.

Table of Contents

  1. Cover
  2. Endorsement
  3. Series
  4. Title Page
  5. Copyright
  6. Preface to the Third Edition
  7. Acknowledgments
  8. An Overview of Global Fixed Income Markets
    1. A SNAPSHOT OF GLOBAL FIXED INCOME MARKETS
    2. FIXED INCOME MARKETS IN THE UNITED STATES
    3. FIXED INCOME MARKETS IN EUROPE
    4. FIXED INCOME MARKETS IN JAPAN
  9. Part One: The Relative Pricing of Securities with Fixed Cash Flows
    1. Chapter 1: Prices, Discount Factors, and Arbitrage
      1. THE CASH FLOWS FROM FIXED-RATE GOVERNMENT COUPON BONDS
      2. DISCOUNT FACTORS
      3. THE LAW OF ONE PRICE
      4. ARBITRAGE AND THE LAW OF ONE PRICE
      5. APPLICATION: STRIPS AND THE IDIOSYNCRATIC PRICING OF U.S. TREASURY NOTES AND BONDS
      6. ACCRUED INTEREST
      7. APPENDIX A: DERIVING REPLICATING PORTFOLIOS
      8. APPENDIX B: THE EQUIVALENCE OF THE DISCOUNTING AND ARBITRAGE PRICING APPROACHES
    2. Chapter 2: Spot, Forward, and Par Rates
      1. SIMPLE INTEREST AND COMPOUNDING
      2. EXTRACTING DISCOUNT FACTORS FROM INTEREST RATE SWAPS
      3. DEFINITIONS OF SPOT, FORWARD, AND PAR RATES
      4. CHARACTERISTICS OF SPOT, FORWARD, AND PAR RATES
      5. TRADING CASE STUDY: TRADING AN ABNORMALLY DOWNWARD-SLOPING 10S-30S EUR FORWARD RATE CURVE IN Q2 2010
      6. APPENDIX A: COMPOUNDING CONVENTIONS
      7. APPENDIX B: CONTINUOUSLY COMPOUNDED SPOT AND FORWARD RATES
      8. APPENDIX C: FLAT SPOT RATES IMPLY FLAT PAR RATES
      9. APPENDIX D: A USEFUL SUMMATION FORMULA
      10. APPENDIX E: THE RELATIONSHIP BETWEEN SPOT AND FORWARD RATES AND THE SLOPE OF THE TERM STRUCTURE
      11. APPENDIX F: THE RELATIONSHIP BETWEEN SPOT AND PAR RATES AND THE SLOPE OF THE TERM STRUCTURE
      12. APPENDIX G: MATURITY, PRESENT VALUE, AND FORWARD RATES
    3. Chapter 3: Returns, Spreads, and Yields
      1. DEFINITIONS
      2. COMPONENTS OF P&L AND RETURN
      3. CARRY-ROLL-DOWN SCENARIOS
      4. APPENDIX A: YIELD ON SETTLEMENT DATES OTHER THAN COUPON PAYMENT DATES
      5. APPENDIX B: P&L DECOMPOSITION ON DATES OTHER THAN COUPON PAYMENT DATES
  10. Part Two: Measures of Interest Rate Risk and Hedging
    1. Chapter 4: One-Factor Risk Metrics and Hedges
      1. DV01
      2. A HEDGING APPLICATION, PART I: HEDGING A FUTURES OPTION
      3. DURATION
      4. CONVEXITY
      5. A HEDGING APPLICATION, PART II: A SHORT CONVEXITY POSITION
      6. ESTIMATING PRICE CHANGES AND RETURNS WITH DV01, DURATION, AND CONVEXITY
      7. CONVEXITY IN THE INVESTMENT AND ASSET-LIABILITY MANAGEMENT CONTEXTS
      8. MEASURING THE PRICE SENSITIVITY OF PORTFOLIOS
      9. YIELD-BASED RISK METRICS
      10. APPLICATION: THE BARBELL VERSUS THE BULLET
    2. Chapter 5: Multi-Factor Risk Metrics and Hedges
      1. KEY-RATE ’01S AND DURATIONS
      2. PARTIAL ’01S AND PV01
      3. FORWARD-BUCKET ’01S
      4. MULTI-FACTOR EXPOSURES AND MEASURING PORTFOLIO VOLATILITY
      5. APPENDIX: SELECTED DETERMINANTS OF FORWARD-BUCKET ’01S
    3. Chapter 6: Empirical Approaches to Risk Metrics and Hedging
      1. SINGLE-VARIABLE REGRESSION-BASED HEDGING
      2. TWO-VARIABLE REGRESSION-BASED HEDGING
      3. LEVEL VERSUS CHANGE REGRESSIONS
      4. PRINCIPAL COMPONENTS ANALYSIS
      5. APPENDIX A: THE LEAST-SQUARES HEDGE MINIMIZES THE VARIANCE OF THE P&L OF THE HEDGED POSITION
      6. APPENDIX B: CONSTRUCTING PRINCIPAL COMPONENTS FROM THREE RATES
  11. Part Three: Term Structure Models
    1. Chapter 7: The Science of Term Structure Models
      1. RATE AND PRICE TREES
      2. ARBITRAGE PRICING OF DERIVATIVES
      3. RISK-NEUTRAL PRICING
      4. ARBITRAGE PRICING IN A MULTI-PERIOD SETTING
      5. EXAMPLE: PRICING A CONSTANT-MATURITY TREASURY SWAP
      6. OPTION-ADJUSTED SPREAD
      7. PROFIT AND LOSS ATTRIBUTION WITH AN OAS
      8. REDUCING THE TIME STEP
      9. FIXED INCOME VERSUS EQUITY DERIVATIVES
    2. Chapter 8: The Evolution of Short Rates and the Shape of the Term Structure
      1. INTRODUCTION
      2. EXPECTATIONS
      3. VOLATILITY AND CONVEXITY
      4. RISK PREMIUM
      5. A MATHEMATICAL DESCRIPTION OF EXPECTATIONS, CONVEXITY, AND RISK PREMIUM
      6. APPLICATION: EXPECTATIONS, CONVEXITY, AND RISK PREMIUM IN USD AND JPY SWAP MARKETS
      7. APPENDIX: PROOF OF EQUATION (8.26)
    3. Chapter 9: The Art of Term Structure Models: Drift
      1. MODEL 1: NORMALLY DISTRIBUTED RATES AND NO DRIFT
      2. MODEL 2: DRIFT AND RISK PREMIUM
      3. THE HO-LEE MODEL: TIME-DEPENDENT DRIFT
      4. DESIRABILITY OF FITTING TO THE TERM STRUCTURE
      5. THE VASICEK MODEL: MEAN REVERSION
    4. Chapter 10: The Art of Term Structure Models: Volatility and Distribution
      1. TIME-DEPENDENT VOLATILITY: MODEL 3
      2. THE COX-INGERSOLL-ROSS AND LOGNORMAL MODELS: VOLATILITY AS A FUNCTION OF THE SHORT RATE
      3. TREE FOR THE ORIGINAL SALOMON BROTHERS MODEL
      4. THE BLACK-KARASINSKI MODEL: A LOGNORMAL MODEL WITH MEAN REVERSION
      5. APPENDIX: CLOSED-FORM SOLUTIONS FOR SPOT RATES
    5. Chapter 11: The Gauss+ and LIBOR Market Models
      1. THE GAUSS+ MODEL
      2. SOLUTION AND ESTIMATION
      3. USD AND EUR SAMPLE RESULTS
      4. MODEL EXTENSIONS
      5. THE LIBOR MARKET MODEL
      6. APPENDIX A: EQUIVALENCE OF THE CASCADE AND REDUCED FORMS OF THE GAUSS+ MODEL
      7. APPENDIX B: THE FUNCTION FOR THE GAUSS+ MODEL
      8. APPENDIX C: ESTIMATING THE PARAMETERS OF THE GAUSS+ MODEL
      9. APPENDIX D: FITTING THE INITIAL TERM STRUCTURE IN THE GAUSS+ MODEL
      10. APPENDIX E: DRAWING RANDOM NUMBERS FROM A MULTIVARIATE NORMAL DISTRIBUTION
  12. Part Four: Selected Securities and Topics
    1. Chapter 12: Repurchase Agreements and Financing
      1. REPURCHASE AGREEMENTS: STRUCTURE AND USES
      2. REPO, LIQUIDITY MANAGEMENT, AND THE FINANCIAL CRISIS OF 2007–2009
      3. GENERAL AND SPECIAL REPO RATES
    2. Chapter 13: Forwards and Futures: Preliminaries
      1. FORWARD CONTRACTS AND FORWARD PRICES
      2. THE FORWARD DROP AND CASH CARRY
      3. FORWARD BOND YIELDS
      4. FORWARD SWAP RATES
      5. INTEREST RATE SENSITIVITY OF FORWARDS
      6. DAILY SETTLEMENT OF FUTURES CONTRACTS
      7. FORWARD AND FUTURES PRICES IN A TERM STRUCTURE MODEL
      8. THE FUTURES-FORWARD DIFFERENCE
      9. FORWARD RATES VERSUS FUTURES ON RATES
      10. TAILS
    3. Chapter 14: Note and Bond Futures
      1. MECHANICS
      2. COST OF DELIVERY AND THE DETERMINATION OF THE FINAL SETTLEMENT PRICE
      3. MOTIVATIONS FOR A DELIVERY BASKET AND CONVERSION FACTORS
      4. IMPERFECTION OF CONVERSION FACTORS AND THE DELIVERY OPTION AT EXPIRATION
      5. GROSS AND NET BASIS
      6. THE QUALITY OPTION BEFORE DELIVERY
      7. SOME NOTES ON PRICING THE QUALITY OPTION IN TERM STRUCTURE MODELS
      8. THE TIMING OPTION
      9. THE END-OF-MONTH OPTION
      10. TRADING CASE STUDY: NOVEMBER ’08 BASIS INTO TYM0 (JUNE 2000)
    4. Chapter 15: Short-Term Rates and Their Derivatives
      1. LIBOR AND LIBOR-RELATED SECURITIES
      2. FED FUNDS AND RELATED SECURITIES
      3. LIBOR-OIS AS AN INDICATOR OF FINANCIAL STRESS
      4. TRADING CASE STUDY: SHORTING THE TED SPREAD OF THE 1 S OF MARCH 15, 2012
    5. Chapter 16: Swaps
      1. SWAP CASH FLOWS
      2. THE VALUATION OF SWAPS
      3. A NOTE ON THE INTEREST RATE RISK OF SWAPS
      4. ON CREDIT RISK AND INTEREST RATE SWAPS
      5. MAJOR USES OF INTEREST RATE SWAPS
      6. THE REGULATORY AND LEGISLATIVE MANDATES TO CLEAR OVER-THE-COUNTER DERIVATIVES
      7. BASIS SWAPS AND SPREADS
      8. CONSTANT MATURITY SWAPS
      9. APPENDIX: DERIVATION OF CONVEXITY CORRECTION FOR CMS SWAPS
    6. Chapter 17: Arbitrage with Financing and Two-Curve Discounting
      1. BOND TRADING WITH FINANCING
      2. BOND ARBITRAGE WITH FINANCING
      3. SWAP TRADING WITH FINANCING
      4. SWAP ARBITRAGE WITH FINANCING
      5. PRICING A USD LIBOR SWAP WITH FED FUNDS AS THE INVESTABLE AND COLLATERAL RATE
      6. APPENDIX A: ARBITRAGE RELATIONSHIPS ACROSS BONDS AND SWAPS WITH FINANCING
      7. APPENDIX B: PRICING SWAPS WITH THE TWO-CURVE APPROACH
    7. Chapter 18: Fixed Income Options
      1. CAPS AND FLOORS
      2. SWAPTIONS
      3. BOND OPTIONS
      4. EURODOLLAR AND EURIBOR FUTURES OPTIONS
      5. BOND FUTURES OPTIONS
      6. SUMMARY OF APPLYING BS TO FIXED INCOME OPTIONS
      7. SWAPTION SKEW
      8. THEORETICAL FOUNDATIONS FOR APPLYING BLACK-SCHOLES TO SELECTED FIXED INCOME OPTIONS
      9. APPENDIX A: EXPECTATIONS FOR BLACK-SCHOLES-STYLE OPTION PRICING
      10. APPENDIX B: EARLY EXERCISE OF AMERICAN-STYLE FUTURES OPTIONS
      11. APPENDIX C: FUTURES PRICES ARE MARTINGALES WITH THE MONEY MARKET ACCOUNT AS A NUMERAIRE
    8. Chapter 19: Corporate Bonds and Credit Default Swaps
      1. CORPORATE SECURITIES
      2. RATINGS, DEFAULT, AND RECOVERY
      3. CREDIT SPREADS
      4. CREDIT SPREADS AND DEFAULT RATES
      5. CREDIT DEFAULT SWAPS
      6. APPENDIX A: CUMULATIVE DEFAULT RATES
      7. APPENDIX B: CDS-BOND BASIS AS THE DIFFERENCE BETWEEN THE CDS SPREAD AND THE PAR ASSET SWAP SPREAD
    9. Chapter 20: Mortgages and Mortgage-Backed Securities
      1. MORTGAGE LOANS
      2. MORTGAGE-BACKED SECURITIES
      3. PREPAYMENT MODELING
      4. MBS VALUATION AND TRADING
      5. PRICE-RATE BEHAVIOR OF MBS
      6. HEDGING REQUIREMENTS OF SELECTED MORTGAGE MARKET PARTICIPANTS
    10. Chapter 21: Curve Construction
      1. INTRODUCTION
      2. FLAT FORWARDS
      3. FLAT FORWARDS FOR A USD LIBOR CURVE
      4. SMOOTH FORWARDS BY PIECEWISE QUADRATICS
      5. LOCALITY PROPERTIES AND HEDGING
  13. References
  14. Index