The Advanced Fixed Income and Derivatives Management Guide

The Advanced Fixed Income and Derivatives Management Guide
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A highly-detailed, practical analysis of fixed income management The Advanced Fixed Income and Derivatives Management Guide provides a completely novel framework for analysis of fixed income securities and portfolio management, with over 700 useful equations. The most detailed analysis of inflation linked and corporate securities and bond options analysis available;, this book features numerous practical examples that can be used for creating alpha transfer to any fixed income portfolio. With a framework that unifies back office operations, such as risk management and portfolio management in a consistent way, readers will be able to better manage all sectors of fixed income, including bonds, mortgages, credits, and currencies, and their respective derivatives, including bond and interest rate futures and options, callable bonds, credit default swaps, interest rate swaps, swaptions and inflation swaps. Coverage includes never-before-seen detail on topics including recovery value, partial yields, arbitrage, and more, and the companion website features downloadable worksheets that can be used for measuring the risks of securities based on the term structure models. Many theoretical models of the Term Structure of Interest Rates (TSIR) lack the accuracy to be used by market practitioners, and the most popular models are not mathematically stable. This book helps readers develop stable and accurate TSIR for all fundamental rates, enabling analysis of even the most complex securities or cash flow structure. The components of the TSIR are almost identical to the modes of fluctuations of interest rates and represent the language with which the markets speak. [ul]Examine unique arbitrage, risk measurement, performance attribution, and replication of bond futures Learn to estimate recovery value from market data, and the impact of recovery value on risks Gain deeper insight into partial yields, product design, and portfolio construction Discover the proof that corporate bonds cannot follow efficient market hypothesis[/ul] This useful guide provides a framework for systematic and consistent management of all global fixed income assets based on the term structure of rates. Practitioners seeking a more thorough management system will find solutions in The Advanced Fixed Income and Derivatives Management Guide .

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Saied Simozar. The Advanced Fixed Income and Derivatives Management Guide

List of Tables

List of Figures

Abbreviations

Notation

SUBSCRIPTS

VARIABLE NAMES

Preface

Acknowledgement

Foreword

About the Author

Introduction

Chapter 1. Review of Market Analytics

1.1 BOND VALUATION

1.2 SIMPLE BOND ANALYTICS

1.3 PORTFOLIO ANALYTICS

1.4 KEY RATE DURATIONS

Chapter 2. Term Structure of Rates

2.1 LINEAR AND NON-LINEAR SPACE

2.2 BASIS FUNCTIONS

2.3 DECAY COEFFICIENT

2.4 FORWARD RATES

2.5 PAR CURVE

2.6 APPLICATION TO THE US YIELD CURVE

2.7 HISTORICAL YIELD CURVE COMPONENTS

2.8 SIGNIFICANCE OF THE TERM STRUCTURE COMPONENTS

2.9 ESTIMATING THE VALUE OF THE DECAY COEFFICIENT

Chapter 3. Comparison of Basis Functions

3.1 POLYNOMIAL BASIS FUNCTIONS

3.2 EXPONENTIAL BASIS FUNCTIONS

3.3 ORTHOGONAL BASIS FUNCTIONS

3.4 KEY BASIS FUNCTIONS

3.5 TRANSFORMATION OF BASIS FUNCTIONS

3.6 COMPARISON WITH THE PRINCIPAL COMPONENTS ANALYSIS

3.7 MEAN REVERSION

3.8 HISTORICAL TABLES OF BASIS FUNCTIONS

Chapter 4. Risk Measurement

4.1 INTEREST RATE RISKS

4.2 ZERO COUPON BONDS EXAMPLES

4.3 EURODOLLAR FUTURES CONTRACTS EXAMPLES

4.4 CONVENTIONAL DURATION OF A PORTFOLIO

4.5 RISKS AND BASIS FUNCTIONS

4.6 APPLICATION TO KEY RATE DURATION

4.7 RISK MEASUREMENT OF A TREASURY INDEX

Chapter 5. Performance Attribution

5.1 CURVE PERFORMANCE

5.2 YIELD PERFORMANCE

5.3 SECURITY PERFORMANCE

5.4 PORTFOLIO PERFORMANCE

Chapter 6. Libor and Swaps

6.1 TERM STRUCTURE OF LIBOR

6.2 ADJUSTMENT TABLE FOR RATES

6.3 RISK MEASUREMENT AND PERFORMANCE ATTRIBUTION OF SWAPS

6.4 FLOATING LIBOR VALUATION AND RISKS

6.5 REPO AND FINANCING RATE

6.6 STRUCTURAL PROBLEM OF SWAPS

Chapter 7. Trading

7.1 LIQUIDITY MANAGEMENT

7.2 FORWARD PRICING

7.3 CURVE TRADING

7.4 SYNTHETIC SECURITIES

7.5 REAL TIME TRADING

Chapter 8. Linear Optimization and Portfolio Replication

8.1 PORTFOLIO OPTIMIZATION EXAMPLE

8.2 CONVERSION TO AND FROM CONVENTIONAL KRD

8.3 KRD AND TERM STRUCTURE HEDGING

Chapter 9. Yield Volatility

9.1 PRICE FUNCTION OF YIELD VOLATILITY

9.2 TERM STRUCTURE OF YIELD VOLATILITY

9.3 VOLATILITY ADJUSTMENT TABLE

9.4 FORWARD AND INSTANTANEOUS VOLATILITY

Chapter 10. Convexity and Long Rates

10.1 THEOREM: LONG RATES CAN NEVER CHANGE

10.2 CONVEXITY ADJUSTED TSIR

10.3 APPLICATION TO CONVEXITY

10.4 CONVEXITY BIAS OF EURODOLLAR FUTURES

Chapter 11. Real Rates and Inflation Expectations

11.1 TERM STRUCTURE OF REAL RATES

11.2 THEOREM: REAL RATES CANNOT HAVE LOG-NORMAL DISTRIBUTION

11.3 INFLATION LINKED BONDS

11.4 SEASONAL ADJUSTMENTS TO INFLATION

11.5 INFLATION SWAPS

Chapter 12. Credit Spreads

12.1 EQUILIBRIUM CREDIT SPREAD

12.2 TERM STRUCTURE OF CREDIT SPREADS

12.3 RISK MEASUREMENT OF CREDIT SECURITIES

12.4 CREDIT RISKS EXAMPLE

12.5 FLOATING RATE CREDIT SECURITIES

12.6 TSCS EXAMPLES

12.7 RELATIVE VALUES OF CREDIT SECURITIES

12.8 PERFORMANCE ATTRIBUTION OF CREDIT SECURITIES

12.9 TERM STRUCTURE OF AGENCIES

12.10 PERFORMANCE CONTRIBUTION

12.11 PARTIAL YIELD

Chapter 13. Default and Recovery

13.1 RECOVERY, GUARANTEE AND DEFAULT PROBABILITY

13.2 RISK MEASUREMENT WITH RECOVERY

13.3 PARTIAL YIELD OF COMPLEX SECURITIES

13.4 FORWARD COUPON

13.5 CREDIT DEFAULT SWAPS

Chapter 14. Deliverable Bond Futures and Options

14.1 SIMPLE OPTIONS MODEL

14.2 CONVERSION FACTOR

14.3 FUTURES PRICE ON DELIVERY DATE

14.4 FUTURES PRICE PRIOR TO DELIVERY DATE

14.5 EARLY VERSUS LATE DELIVERY

14.6 STRIKE PRICES OF THE UNDERLYING OPTIONS

14.7 RISK MEASUREMENT OF BOND FUTURES

14.8 ANALYTICS FOR BOND FUTURES

14.9 AUSTRALIAN BOND FUTURES

14.10 REPLICATION OF BOND FUTURES

Chapter 15. Bond Options

15.1 EUROPEAN BOND OPTIONS

15.2 EXERCISE BOUNDARY OF AMERICAN OPTIONS

15.3 PRESENT VALUE OF A FUTURE BOND OPTION

15.4 FEEDFORWARD PRICING

15.5 BOND OPTION GREEKS

15.6 RISK MEASUREMENT OF BOND OPTIONS

15.7 TREASURY AND REAL BONDS OPTIONS

15.8 BOND OPTIONS WITH CREDIT RISK

15.9 THEOREM: CREDIT PRICES ARE NOT ARBITRAGE-FREE

15.1 °CORRELATION MODEL

15.11 CREDIT BOND OPTIONS EXAMPLES

15.12 RISK MEASUREMENT OF COMPLEX BOND OPTIONS

15.13 REMARKS ON BOND OPTIONS

Chapter 16. Currencies

16.1 CURRENCY FORWARDS

16.2 CURRENCY AS AN ASSET CLASS

16.3 CURRENCY TRADING AND HEDGING

16.4 VALUATION AND RISKS OF CURRENCY POSITIONS

16.5 CURRENCY FUTURES

16.6 CURRENCY OPTIONS

Chapter 17. Prepayment Model

17.1 HOME SALE

17.2 REFINANCING

17.3 ACCELERATED PAYMENTS

17.4 PREPAYMENT FACTOR

Chapter 18. Mortgage Bonds

18.1 MORTGAGE VALUATION

18.2 CURRENT COUPON

18.3 MORTGAGE ANALYTICS

18.4 MORTGAGE RISK MEASUREMENT AND VALUATION

Chapter 19. Product Design and Portfolio Construction

19.1 PRODUCT ANALYZER

19.2 PORTFOLIO ANALYZER

19.3 COMPETITIVE UNIVERSE

19.4 PORTFOLIO CONSTRUCTION

Chapter 20. Calculating Parameters of the TSIR

20.1 OPTIMIZING TSIR

20.2 OPTIMIZING TSCR

20.3 OPTIMIZING TSCR WITH NO CONVEXITY

20.4 ESTIMATING RECOVERY VALUE

20.5 ROBUSTNESS OF THE TERM STRUCTURE COMPONENTS

20.6 CALCULATING THE COMPONENTS OF THE TSYV

Chapter 21. Implementation

21.1 TERM STRUCTURE

21.1.1 Primary Curve

21.1.2 Real Curve

21.1.3 Credit Curve and Recovery Value

21.2 DISCOUNT FUNCTION AND RISK MEASUREMENT

21.3 CASH FLOW ENGINE

21.4 INVOICE PRICE

21.5 ANALYTICS

21.6 TRADE DATE VERSUS SETTLE DATE

21.7 AMERICAN OPTIONS

21.8 LINEAR PROGRAMMING

21.9 MORTGAGE ANALYSIS

References

Index

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For notational convenience most variable names have been limited to a single character. Subscripts have been used to differentiate related variables. Subscripts i, j, and k have been used exclusively as running integers and are interchangeable. Other subscript letters are used to differentiate closely related names. For example, pm and pc are used for the market price and calculated price of a security, respectively. When these subscripts are mixed with running subscripts, a comma is inserted between them (e.g. pm,i or pc,k).

Understanding the factors that contribute to risk and return are essential, in order to structure a sound portfolio. Risk management and return attribution require the quantification of sources of risk and return and thus are math intensive. A portfolio manager who is familiar with linear programming can structure an optimum portfolio based on analysts' recommendations, portfolios policies and guidelines as well as his own views of the markets that is likely to have a superior return than another portfolio of similar weights and risk profiles.

.....

The change in the price of a security due to a small change in its yield in the continuously compounded framework is

1.18

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