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Mastering Financial Calculations: A step-by-step guide to the mathematics of financial market instruments, Second edition

Book Description

The new rebranded and updated edition of the bestselling hands-on practitioner¿s guide to the maths behind every key financial instrument and technique. 

  • Part of the renowned and hugely successful Mastering series.

  • This is the definitive guide to exploring today’s financial markets in a clear and comprehensive manner.

  • Written by Robert Steiner, one of the UK’s leading trainers for some of the world’s largest financial institutions.

  • The book includes essential course material and practice exercises for ACI qualifications

  • This book has practicality-not theory-at its heart and is packed with real-world cases, worked examples and calculations.

  • AUDIENCE: Practitioners are the primary market: traders, fund managers, corporate treasurers, programmers, accountants, and risk managers. Secondary are market students.

  • This book will appeal to a huge audience. 1 in 10 people work in either banking, finance or insurance.

  • Table of Contents

    1. Copyright
      1. Dedication
    2. Author’s note
    3. The author
    4. Foreword
    5. Introduction
      1. The Aim of the Book
      2. The Structure of the Book
        1. Part 1: The basics
        2. Part 2: Interest rate instruments
        3. Part 3: Foreign exchange
        4. Part 4: Swaps and options
        5. Part 5: Gold and other commodities
        6. Part 6: Hints and answers to exercises
      3. Key Features of the Book
        1. Key points
        2. Calculation summaries
        3. Glossary
        4. Market interest conventions
        5. Examples
        6. Exercises
        7. Calculator keystrokes
      4. A Final Word
    6. 1. The Basics
      1. 1. Financial Arithmetic Basics
        1. Some Opening Remarks on Formulas
        2. Use of an HP Calculator
        3. Simple and Compound Interest
          1. Simple interest
          2. Compound interest
          3. Nominal rates and effective rates
          4. Continuous compounding
          5. Reinvestment rates
        4. Nominal and Effective Rates
          1. 1. The period for which the investment/loan will last
          2. 2. The absolute period to which the quoted interest rate applies
          3. 3. The frequency with which interest is paid
        5. Future Value/Present Value; Time Value of Money
          1. Short-term investments
          2. Long-term investments
        6. Discount Factors
        7. Cashflow Analysis
          1. NPV
          2. IRR
          3. Money-weighted, and time-weighted, rates of return
        8. Annuities
        9. Using an HP Calculator for Cashflow Analysis
        10. Interpolation and Extrapolation
        11. Mean, Variance, Standard Deviation and Volatility
          1. Calculating historic volatility
        12. Correlation and Covariance
        13. The ‘Normal’ Probability Function
          1. Probability density
          2. Probability distribution
        14. Exercises
    7. 2. Interest Rate Instruments
      1. 2. The Money Market
        1. Overview
          1. Negotiable security
        2. Day/Year Conventions
          1. Effective rates
        3. Money Market Instruments
          1. Time deposit/loan
          2. Certificate of deposit (CD)
          3. Treasury bill (T-bill)
          4. Commercial paper (CP)
          5. Bill of exchange
          6. Repurchase agreement (repo)
        4. Money Market Calculations
        5. Discount Instruments
          1. Discount/true yield
          2. Bond-equivalent yields
        6. CDs Paying More Than One Coupon
        7. Exercises
      2. 3. Forward-Forwards and Forward Rate Agreements (FRAs)
        1. Forward-Forwards, FRAs and Futures
          1. Overview
          2. Pricing a forward-forward
          3. Forward rate agreements (FRAs)
            1. Pricing
            2. Quotation
            3. Settlement
            4. Dates
          4. The short-term yield curve
          5. Constructing a strip
        2. Applications of FRAs
          1. Hedging
          2. Speculation
          3. Calendar spread
          4. Arbitrage
        3. Exercises
      3. 4. Interest Rate Futures
        1. Overview
          1. The “underlying”
          2. Value dates
          3. Settlement price
          4. Profit and loss and “basis point value”
          5. “Tick” and “tick value”
          6. Some financial futures exchanges and contracts
        2. Exchange Structure and Margins
          1. Market participants
          2. Dealing
          3. Clearing
          4. Margin requirements
          5. Delivery
          6. Limit up/down
        3. Futures Compared with FRAs
          1. OTC vs. exchange-traded
        4. Pricing and Hedging FRAs with Futures
          1. Hedging the basis risk
        5. Trading with Interest Rate Futures
          1. Basis
          2. Volume and open interest
          3. Speculation
          4. Arbitrage
          5. Calendar spread
          6. Cross-market spread
          7. Strip trading
          8. The convexity bias
        6. Exercises
      4. 5. Bond Market Calculations
        1. Overview of Capital Market Instruments
          1. Domestic, foreign and Eurobonds
          2. Government bond markets
          3. USA
          4. UK
          5. Germany
          6. France
        2. Features and Variations
          1. Floating rate note (FRN)
          2. Index-linked bonds
          3. Zero-coupon bonds
          4. Strips
          5. Amortisation
          6. Perpetual bonds
          7. Calls and puts
          8. Bond warrants
          9. Medium-term note (MTN)
          10. Securitisation
            1. Asset-backed security
            2. Asset-covered security/covered bond
        3. Introduction to Bond Pricing
          1. Accrued interest
          2. Coupon dates
          3. Ex-dividend
          4. Day/year conventions
          5. Irregular first or final coupon period
          6. Using an HP calculator
            1. To calculate the clean price from the yield
            2. To calculate the yield from the clean price
        4. Different Yield Measures and Price Calculations
          1. Yield to maturity
          2. Yield vs. coupon
          3. Current yield
          4. Simple yield to maturity
          5. Yield in a final coupon period
          6. Bond-equivalent yields for treasury bills
          7. Money market yield
          8. Moosmüller yield
          9. Zero-coupon and strip prices
        5. A Summary of the Various Approaches to Price/Yield
          1. Day/year convention for accrued coupon
          2. Day/year convention for discounting cashflows to the dirty price
          3. Adjustment for non-working days
          4. Simple interest vs. compound interest
          5. Compounding method
          6. Other considerations
        6. Duration, Modified Duration and Convexity
          1. Duration
          2. Modified duration
          3. Dollar value of an 01
          4. Convexity
          5. Portfolio duration
        7. Bond Futures
          1. Bond specification
          2. Deliverable bonds and conversion factors
          3. Delivery date
          4. Coupons
          5. Pricing
            1. Receive on delivery of the bond
            2. Receive as variation margin
            3. Receive any intervening coupon
            4. Pay the total cost of funding the cash bond purchase
            5. Pay (or receive) the cost of the difference between the amount of bond hedged and the amount of the bond to be delivered to the buyer
          6. Forward bond prices
          7. Using futures to hedge a cash position
        8. Cash-and-Carry Arbitrage
          1. Overview of repos
            1. Price calculation
          2. Implied repo rate
          3. Cheapest-to-deliver bond
          4. The arbitrage structure
          5. Basis, net cost of carry and net basis
        9. Exercises
      5. 6. Repos, Buy/Sell-backs and Securities Lending
        1. Introduction
        2. Classic Repo
          1. Price calculation
          2. Coupon payments
        3. Margin Calls
          1. Haircut
        4. General Collateral (GC) and Specials
        5. Other Features
          1. Substitution
          2. Cross-currency repo
          3. Maturity
          4. Other possibilities
            1. Flex repo
            2. Repo to maturity
            3. Dollar repo
            4. Forward-start repo
            5. Floating-rate repo
          5. Bilateral, triparty and hold-in-custody repos
          6. The repo rate
          7. Eurepo
        6. Buy/Sell-Back
          1. Price calculation
          2. Coupon payments
        7. Close-Out and Repricing
          1. Close-out and repricing with adjustment of the cash amount
          2. Close-out and repricing with adjustment of the collateral amount
          3. Substitution and maturity
        8. Securities Lending
          1. Collateral
          2. Coupon payments and other rights
          3. Margin
          4. Other features
          5. The lending fee
        9. Comparison between the Different Transactions
        10. Uses of Repo and Securities Lending
          1. Cash borrowing
          2. Funding a long bond position
          3. Covering a short bond position
          4. Secured cash investment
          5. Matched book dealing – taking a view on interest rates
          6. Matched book dealing – taking a view on specials
          7. Fund management – yield enhancement
          8. Fund managers – leverage
          9. Cash and carry arbitrage
          10. Hedging derivatives positions
          11. Central banks
        11. Exercises
      6. 7. Zero-coupon Rates and Yield Curves
        1. Zero-Coupon Yields and Par Yields
          1. Constructing par yields from zero-coupon yields
          2. Zero-coupon yields from coupon-bearing yields
        2. Forward-Forward Yields
          1. Constructing forward-forward yields from zero-coupon yields
          2. Zero-coupon yields from forward-forward yields
        3. Summary
        4. Longer-Dated FRAs
        5. Exercises
    8. 3. Foreign Exchange
      1. 8. Foreign Exchange
        1. Introduction
        2. Spot Exchange Rates
          1. How spot rates are quoted
          2. Cross-rates
        3. Forward Exchange Rates
          1. Forward outrights
          2. Forward swaps
          3. Discounts and premiums
            1. Terminology
          4. A forward swap position
          5. Historic rate rollovers
          6. Covered interest arbitrage
        4. Cross-Rate Forwards
          1. Outrights
          2. Swaps
        5. Short Dates
        6. Calculation Summary
        7. Value Dates
        8. Forward-Forwards
        9. Time Options
        10. Long-Dated Forwards
        11. Arbitraging and Creating FRAs
        12. Discounting Future Foreign Exchange Risk
        13. Exercises
    9. 4. Swaps and Options
      1. 9. Interest Rate and Currency Swaps
        1. Basic Concepts and Applications
          1. Hedging borrowing costs
          2. Relative advantage in borrowing
          3. Asset swap
          4. Speculation
          5. Basis swap
        2. Overnight Indexed Swap (OIS)
          1. Trading and hedging with an OIS
        3. Pricing
          1. Day/year conventions
            1. Modified following
            2. ACT/ACT
            3. ACT/365
            4. 30/360
          2. Converting between different quotation bases
          3. Prices quoted as a spread over government bonds
          4. The pricing link between FRAs and interest rate swaps
          5. Pricing longer-term swaps
        4. Valuing Swaps
          1. Marking-to-market a swap
          2. Reversing a swap transaction
          3. Constructing an asset swap
        5. Hedging an Interest Rate Swap
        6. Amortising and Forward-Start Swaps
          1. Amortising swap
          2. Forward-start swap
          3. Delayed-start swap
        7. Currency Swaps
          1. Cross-currency basis swaps
        8. Exercises
      2. 10. Options
        1. Overview
          1. Basic terminology
        2. The Ideas Behind Option Pricing
          1. The concepts
        3. Pricing Models
          1. Black–Scholes
          2. Binomial trees
            1. Risk-free portfolio
            2. Comparison with Black–Scholes
          3. Put/call relationship, synthetic forwards and risk reversal
        4. OTC Options vs. Exchange-Traded Options
        5. The Greek Letters
          1. Delta
          2. Gamma
          3. Vega
          4. Theta
          5. Rho
        6. Hedging with Options
          1. Comparison with forwards
          2. Interest rate guarantees
          3. Caps and floors
        7. Some “Packaged” Options
          1. Range forward (or collar, cylinder or tunnel)
          2. Break forward (or forward with optional exit)
          3. Participation forward
        8. Some Trading Strategies
          1. Calls and puts
          2. Covered calls and puts
          3. Spread
          4. Straddle
          5. Strangle
        9. Some Less Straightforward Options
          1. Average rate option (or Asian option)
          2. Average strike option
          3. Barrier option
          4. Binary option (or digital option)
          5. Compound option
          6. Contingent option
          7. Quanto option (or guaranteed exchange rate option)
          8. Swaption
        10. Exercises
    10. 5. Gold and Other Commodities
      1. 11. Gold and Other Commodities
        1. Gold
          1. Pricing
          2. Allocated and unallocated delivery
          3. The gold fix
        2. Gold Borrowing, Forwards, Swaps and GOFO
          1. Borrowing gold
          2. Forward transactions in gold
            1. Contango and backwardation
          3. Gold swaps
          4. GOFO
            1. Location swaps
          5. Futures, FRAs, interest rate swaps and options
        3. Other Commodities
        4. Forward Pricing and Convenience Yield
          1. Forward commodity pricing
          2. Convenience yield
            1. Contango and backwardation (again!)
        5. Commodity Futures and EFP (Exchange for Physical)
          1. EFP – exchange for physical
            1. Converting a futures position to a physical OTC position
            2. Converting a physical OTC trade to a futures position
        6. FRAs, Swaps and Options
          1. Options
        7. Exercises
    11. 6. Hints and Answers to Exercises
      1. 12. Hints and Answers to Exercises
        1. Hints on exercises
        2. Answers to exercises
    12. Appendices
      1. 1. Using an HP calculator
        1. Introduction
          1. The HP12C calculator
          2. The HP17BII and HP19BII
          3. Basic operations
            1. Switching between algebraic and RPN modes
            2. Deleting an incorrect entry
            3. Number of decimal places
            4. Addition
            5. Subtraction
            6. Multiplication, division
            7. Exponents
            8. Chaining
            9. Reversing the order of the current operation
            10. Square roots
            11. Reciprocals
            12. Function menus
            13. Date calculations
          4. Other operations
      2. 2. A summary of market day/year conventions for money markets and government bond markets
        1. Notes
      3. 3. A summary of calculation procedures
        1. Notation
        2. Financial arithmetic basics (Chapter 1)
          1. Effective and nominal rates
          2. Continuously compounded interest rate
          3. Short-term investments
          4. Long-term investments over N years
          5. NPV and internal rate of return
          6. Annuities
          7. Interpolation and extrapolation
          8. Basic statistics
          9. Historic volatility
        3. The money market (Chapter 2)
          1. Certificate of deposit
          2. Discount instrument
          3. Instruments quoted on a discount rate
          4. Medium-term CD
        4. Forward-forwards and forward rate agreements (Chapter 3)
          1. Constructing a strip
        5. Interest rate futures (Chapter 4)
        6. Bond market calculations (Chapter 5)
          1. General dirty price formula
          2. Conventional dirty price formula
          3. Other yields
          4. Alternative yield in final coupon period (simple)
          5. Bond equivalent yield for US T-bill
          6. Money market yield
          7. Moosmüller yield
          8. Duration and convexity
            1. Approximation
            2. Better approximation
            3. Approximations for a portfolio
          9. Bond futures
            1. Hedge ratio
            2. Cash-and-carry arbitrage
        7. Zero-coupon rates and yield curves (Chapter 7)
          1. Creating a strip
          2. Conversion between yield curves
        8. Foreign exchange (Chapter 8)
          1. To calculate cross-rates
            1. In general
          2. Forwards
            1. Approximations
          3. Premiums and discounts
          4. Covered interest arbitrage
          5. Forward-forward price after spot
          6. Time option
          7. Long-dated forwards
          8. Covered interest arbitrage (forward)
        9. Interest rate swaps and currency swaps (Chapter 9)
          1. Pricing interest rate swaps from futures or FRAs
          2. Valuing swaps
        10. Options (Chapter 10)
          1. Price quotation
          2. Black–Scholes
            1. Option-pricing formula for a non-dividend-paying asset
            2. Currency option pricing formula (Garman-Kohlhagen)
          3. Put–call relationship
            1. Synthetic forwards
            2. Risk reversal
          4. Option price sensitivities
            1. Based on the Black–Scholes formula
        11. Gold and other commodities (Chapter 11)
          1. Forward prices
            1. Approximation
            2. Approximation
            3. Approximation
          2. Forwards and convenience yield
            1. For storable commodities
      4. 4. Glossary
      5. 5. ISO (SWIFT) currency codes
    13. Select Bibliography
      1. General
      2. Money market
      3. Bond market calculations
      4. Repos
      5. Swaps
      6. Options
      7. Commodities