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Bond and Money Markets: Strategy, Trading, Analysis

Bond and Money Markets: Strategy, Trading, Analysis

by Moorad Choudhry
Publisher: Butterworth-Heinemann
Release Date: May 2001
ISBN: 9780750646772
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Book Description

Bond and Money Markets: Strategy, Trading, Analysis explains and analyses all aspects of the bond and money markets and is both an introduction for newcomers and an advanced text for experienced market practitioners and graduate students. Those with experience of the industry at all levels will find the book invaluable as a standard reference work. The book features coverage of:

  • Government and Corporate bonds, Eurobonds, callable bonds, convertibles
  • Asset-backed bonds including mortgages and CDOs
  • Derivative instruments including bond futures, swaps, options, structured products, and option valuation models
  • Interest-rate risk, duration analysis, convexity, and the convexity bias
  • The money markets, repo markets, basis trading, and asset / liability management
  • Term structure models, estimating and interpreting the yield curve
  • Portfolio management, including total return framework, portfolio strategies, and constructing bond indices

and valuable insight into:

  • Trading and hedging strategy
  • Charting and technical analysis
  • The latest market developments, such as value-at-risk, and credit derivatives
  • Emerging markets and the benefits of international investment

The Bond and Money Markets: Strategy, Trading, Analysis is aimed at a wide readership including bond salespersons, traders, corporate financiers and graduate trainees, as well as risk managers, operations professionals and business analysts. Other market participants including fund managers, corporate treasurers, management consultants, regulators and financial journalists will also find the content useful.

  • This book is virtually a stand alone reference book on interest rate swaps, the money markets, financial market mathematics, interest-rate futures and technical analysis
  • Includes some introductory coverage of very specialised topics (for which one requires specialised texts) such as VaR, Asset & liability management, credit derivatives
  • Combines accessible style with advanced level topics, plus review of latest research

Table of Contents

  1. Cover image
  2. Title page
  3. Table of Contents
  4. Copyright page
  5. Dedication
  6. Foreword
  7. Preface
    1. The capital markets
    2. Efficient markets
    3. Intended audience
    4. Organisation of the book
    5. Study materials
    6. Acknowledgements
  8. About the author
  9. Part I: Introduction to the Bond Markets
    1. Introduction
    2. 1: The Debt Capital Markets
      1. 1.1 Description
      2. 1.2 Bond issuers
      3. 1.3 Capital market participants
      4. 1.4 World bond markets
      5. 1.5 Overview of the main bond markets
      6. 1.6 Financial engineering in the bond markets
      7. Appendices
      8. Questions and exercises
    3. 2: Financial Markets Arithmetic
      1. 2.1 Simple and compound interest
      2. 2.2 The time value of money
      3. 2.3 Multiple cash flows
      4. 2.4 Corporate finance project appraisal
      5. 2.5 Interpolation and extrapolation
      6. 2.6 Measuring the rate of return
      7. 2.7 Indices
      8. Appendices
      9. Questions and exercises
    4. 3: Traditional Bond Pricing
      1. 3.1 Pricing a conventional bond
      2. 3.2 Pricing zero-coupon bonds
      3. 3.3 Clean and dirty bond prices
      4. 3.4 Bond price and yield relationship
      5. Questions and exercises
    5. 4: Bond Yield Measurement
      1. 4.1 Current yield
      2. 4.2 Simple yield to maturity
      3. 4.3 Yield to maturity
      4. 4.4 Yield on a zero-coupon bond
      5. 4.5 Modifying bond yields
      6. 4.6 Converting bond yields
      7. 4.7 Assumptions of the redemption yield calculation
      8. 4.8 Holding-period yield
      9. 4.9 Bonds with embedded options
      10. 4.10 Index-linked bonds
      11. 4.11 Yields on floating-rate bonds
      12. 4.12 Measuring yield for a bond portfolio
      13. 4.13 The price/yield relationship
      14. 4.14 Summary
      15. Appendices
      16. Questions and exercises
    6. 5: Review of Bond Market Instruments
      1. 5.1 Floating Rate Notes
      2. 5.2 Inverse/Reverse floating-rate bonds
      3. 5.3 Asset-backed bonds
      4. 5.4 PIBS
      5. 5.5 Callable bonds
      6. 5.6 Index-linked bonds
      7. Appendices
      8. Questions and exercises
    7. 6: The Yield Curve
      1. 6.1 Using the yield curve
      2. 6.2 Yield-to-maturity yield curve
      3. 6.3 The coupon yield curve
      4. 6.4 The par yield curve
      5. 6.5 The zero-coupon (or spot) yield curve
      6. 6.6 The forward yield curve
      7. 6.7 The annuity yield curve
      8. 6.8 Analysing and interpreting the yield curve
      9. 6.9 Interpreting the yield curve
      10. 6.10 Fitting the yield curve
      11. 6.11 Spot and forward rates in the market
      12. 6.12 Examples, exercises and calculations
      13. 6.13 Case Study: Deriving a discount function28
      14. 6.14 Case Study exercise: Deriving the theoretical zero-coupon (spot) rate curve29
      15. Appendices
      16. Questions and exercises
    8. 7: Price, Yield and Interest Rate Risk I
      1. 7.1 Revisiting the bond price/yield relationship
      2. 7.2 Duration
      3. 7.3 A summary of the duration measure
      4. 7.4 Duration for other securities
      5. Appendices
      6. Questions and exercises
    9. 8: Price, Yield and Interest Rate Risk II
      1. 8.1 Basis point value
      2. 8.2 Yield value of price change
      3. 8.3 Hedging using basis point value
      4. 8.4 Volatility weighting for hedging
      5. Questions and exercises
    10. 9: Price, Yield and Interest Rate Risk III
      1. 9.1 Convexity
      2. 9.2 Summarising the properties of convexity
      3. 9.3 Dispersion
      4. Appendices
      5. Questions and exercises
    11. 10: Price, Yield and Interest Rate Risk IV
      1. 10.1 Yield curve changes
      2. 10.2 Portfolio duration and changes in the yield curve
      3. 10.3 Hedging strategy and duration
      4. Appendices
      5. Questions and exercises
  10. Part II: Government Bond Markets
    1. Introduction
    2. 11: The United Kingdom Gilt Market
      1. 11.1 Introduction and history
      2. 11.2 Market instruments
      3. 11.3 Taxation
      4. 11.4 Market structure
      5. 11.5 Market makers and brokers
      6. 11.6 Issuing gilts
      7. 11.7 The DMO and secondary market trading
      8. 11.8 Settlement
      9. 11.9 Index-linked gilts analytics
      10. 11.10 Gilt strips
      11. 11.11 Zero-coupon bond trading and strategy
      12. 11.12 Strips market anomalies
      13. 11.13 Trading strategy
      14. 11.14 Illustration: Yield and cash flow analysis
      15. 11.15 Future developments in strips
      16. 11.16 HM Treasury and the remit of the Debt Management Office
      17. 11.17 Gilt derivatives and repo markets
      18. 11.18 The Minimum Funding Requirement
      19. 11.19 Developments in electronic trading
      20. Appendices
      21. Questions and exercises
    3. 12: The US Treasury Bond Market
      1. 12.1 The US Treasury
      2. 12.2 The Federal Reserve
      3. 12.3 Market convention
      4. 12.4 The Primary Market
      5. 12.5 The Secondary Market
      6. 12.6 Treasury strips
      7. 12.7 Inflation-protected Treasury bonds
      8. 12.8 Treasury repo market
      9. 12.9 Federal Agency bonds
      10. 12.10 Derivatives markets
      11. 12.11 Historical long-bond yields
      12. Appendices
      13. Questions and exercises
    4. 13: International Bond Markets
      1. 13.1 Overview of government markets
      2. 13.2 Germany
      3. 13.3 Italy
      4. 13.4 France
      5. 13.5 Japan
      6. 13.6 Australia
      7. 13.7 New Zealand
      8. 13.8 Canada
      9. 13.9 Hungary
      10. 13.10 South Africa
      11. 13.11 Egypt
      12. Appendices
  11. Part III: Corporate Debt Markets
    1. Introduction
    2. 14: Corporate Debt Markets
      1. 14.1 Introduction
      2. 14.2 Determinants of the development of a corporate market
      3. 14.3 The primary market
      4. 14.4 The secondary market
      5. 14.5 Fundamentals of corporate bonds
      6. 14.6 Bond security
      7. 14.7 Redemption provisions
      8. 14.8 Corporate bond risks
      9. 14.9 High-yield corporate bonds
      10. 14.10 Corporate bond offering circular
      11. Questions and exercises
    3. 15: Analysis of Bonds With Embedded Options
      1. 15.1 Understanding embedded option elements in a bond
      2. 15.2 The Binomial tree of short-term interest rates
      3. 15.3 Pricing callable bonds
      4. 15.4 Price and yield sensitivity
      5. 15.5 Price volatility of bonds with embedded options
      6. 15.6 Sinking funds
      7. Appendices
      8. Questions and exercises
    4. 16: Convertible Bonds I
      1. 16.1 Basic description
      2. 16.2 Advantages of issuing and holding convertibles
    5. 17: Convertible Bonds II
      1. 17.1 Traditional valuation methodology
      2. 17.2 Fair value of a convertible bond
      3. 17.3 Further issues in valuing convertible bonds
      4. 17.4 Convertible bond default risk
      5. Appendices
      6. Questions and exercises
    6. 18: The Eurobond Market I
      1. 18.1 Eurobonds
      2. 18.2 Foreign bonds
      3. 18.3 Eurobond instruments
      4. 18.4 The issuing process: market participants
      5. 18.5 Fees, expenses and pricing
      6. 18.6 Issuing the bond
      7. 18.7 Covenants
      8. 18.8 Trust services
      9. 18.9 Form of the bond
      10. 18.10 Clearing systems
      11. 18.11 Market associations
      12. 18.12 Secondary market
      13. 18.13 Settlement
    7. 19: Eurobonds II
      1. 19.1 Legal and tax issues
      2. 19.2 The secondary market
      3. 19.3 Eurobonds and swap transactions
    8. 20: Warrants
      1. 20.1 Introduction
      2. 20.2 Analysis
      3. 20.3 Bond warrants
      4. 20.4 Comparison of warrants and convertibles
    9. 21: Medium-term Notes
      1. 21.1 Introduction
      2. 21.2 The primary market
      3. 21.3 MTNs and corporate bonds
      4. 21.4 Issue mechanism
      5. 21.5 The secondary market
      6. 21.6 The Euro-MTN market
      7. 21.7 Structured MTNs
      8. Questions and exercises
    10. 22: Commercial Paper
      1. 22.1 Commercial Paper programmes
      2. 22.2 Commercial paper yields
      3. Questions and exercises
    11. 23: Preference Shares and Preferred Stock
      1. 23.1 The size of the market
      2. 23.2 Description and definition of preference shares
      3. 23.3 Cost of preference share capital
      4. 23.4 The preference share market
      5. 23.5 Auction market preferred stock (Amps)
    12. 24: The US Municipal Bond Market
      1. 24.1 Description of municipal bonds
      2. 24.2 The municipal bond market
      3. 24.3 Municipal bonds credit ratings
      4. 24.4 Bond insurance
      5. 24.5 Taxation issues
      6. 24.6 Exotic municipal bonds
      7. 24.7 Municipal money market instruments
      8. Appendices
    13. 25: Asset-Backed Bonds I: Mortgage-backed Securities
      1. 25.1 Mortgage-backed securities
      2. 25.2 Cash flow patterns
      3. 25.3 Evaluation and analysis of mortgage-backed bonds
      4. Questions and exercises
    14. 26: Mortgage-backed Bonds II
      1. 26.1 Basic concepts
      2. 26.2 Pricing and modelling techniques
      3. 26.3 Interest rate risk
      4. 26.4 Portfolio performance
    15. 27: Asset-backed Securities III
      1. 27.1 Collateralised mortgage securities
      2. 27.2 Non-agency CMO bonds
      3. 27.3 Commercial mortgage-backed securities
      4. 27.4 Motor-car-backed securities
      5. 27.5 Credit card asset-backed securities
      6. 27.6 Static spread analysis of asset-backed bonds
      7. 27.7 Conclusion
      8. Questions and exercises
    16. 28: Collateralised Debt Obligations
      1. 28.1 An overview of CDOs
      2. 28.2 Relative value analysis
      3. 28.3 Credit derivatives6
    17. 29: High-yield Bonds
      1. 29.1 Growth of the market
      2. 29.2 High-yield securities
      3. 29.3 High-yield bond performance
    18. 30: Corporate Bonds and Credit Analysis
      1. 30.1 Credit ratings
      2. 30.2 Credit analysis
      3. 30.3 Industry-specific analysis
      4. 30.4 The art of credit analysis
      5. Questions and exercises
  12. Part IV: The Money Markets
    1. Introduction
    2. 31: The Money Markets
      1. 31.1 Introduction
      2. 31.2 Securities quoted on a yield basis
      3. 31.3 Securities quoted on a discount basis
      4. 31.4 Foreign exchange
      5. Appendices
    3. 32: Banking Regulatory Capital Requirements
      1. 32.1 Regulatory issues
      2. 32.2 Capital adequacy requirements
      3. 32.3 Proposed changes to Basle rules
    4. 33: Asset and Liability Management
      1. 33.1 Introduction
      2. 33.2 The ALM desk
      3. 33.3 Liquidity and interest-rate risk
      4. 33.4 Critique of the traditional approach
      5. 33.5 Securitisation
      6. Appendices
    5. 34: The Repo Markets
      1. 34.1 Development of the repo market
      2. 34.2 Introduction to repo
      3. 34.3 Uses and economic functions of repo
      4. 34.4 Repo mechanics
      5. 34.5 Other repo structures
      6. 34.6 Pricing and margin
      7. 34.7 Risks in dealing repo
      8. 34.8 Legal issues
      9. 34.9 Accounting, Tax and capital issues
      10. 34.10 Market participants
      11. 34.11 The United Kingdom gilt repo market
      12. 34.12 Market structure
      13. 34.13 Trading patterns
      14. 34.14 Open market operations
      15. 34.15 Gilts settlement and the CREST service
      16. 34.16 Gilt repo Code of Best Practice
      17. 34.17 Trading approach
      18. 34.18 Electronic repo trading
      19. 34.19 Repo netting
      20. 34.20 The implied repo rate and basis trading
      21. 34.21 Repo market structures
      22. 34.22 Central bank repo and overseas markets
      23. Appendices
      24. Questions and exercises
    6. 35: Money Markets Derivatives
      1. 35.1 Forward rate agreements
      2. 35.2 FRA mechanics
      3. 35.3 Long-dated FRAs
      4. 35.4 Forward contracts
      5. 35.5 Short-term interest rate futures
      6. Appendices
      7. Questions and exercises
  13. Part V: Risk Management
    1. Introduction
    2. 36: Risk Management
      1. 36.1 Introduction
      2. 36.2 Risk management
      3. 36.3 Non-VaR measure of risk
    3. 37: Bank Risk Exposure and Value-at-Risk
      1. 37.1 Value-at-Risk
      2. 37.2 Explaining Value-at-Risk
      3. 37.3 Variance-covariance Value-at-Risk
      4. 37.4 Historical VaR methodology
      5. 37.5 Simulation methodology
      6. 37.6 Value-at-risk for fixed interest instruments
      7. 37.7 Derivative products and Value-at-Risk
      8. 37.8 Stress testing
      9. 37.9 Value-at-Risk methodology for credit risk
      10. Appendices
      11. Questions and exercises
    4. 38: Interest-rate Risk and a Critique of Value-at-Risk
      1. 38.1 Interest-rate risk
      2. 38.2 Comparison with traditional duration-based risk measurement
      3. 38.3 A critique of Value-at-Risk
  14. Part VI: Derivative Instruments
    1. Introduction
      1. The concept of a traded security
      2. The risk-free hedge
    2. 39: Swaps I
      1. 39.1 Introduction
      2. 39.2 Interest rate swaps
      3. 39.3 Relationship between interest-rate swaps and FRAs
      4. 39.4 Generic swap valuation
      5. 39.5 Zero-coupon swap pricing
      6. 39.6 Non-vanilla interest-rate swaps
      7. 39.7 Cancelling a swap
      8. 39.8 Swaptions
      9. 39.9 Cross-currency swaps
      10. 39.10 Credit risk
      11. Appendices
      12. Questions and exercises
    3. 40: Swaps II
      1. 40.1 Using swaps
      2. 40.2 Hedging an interest-rate swap
      3. 40.3 The convexity bias
      4. 40.4 Swaps netting
      5. Appendices
      6. Questions and exercises
    4. 41: Bond Futures
      1. 41.1 Introduction
      2. 41.2 Futures pricing
      3. 41.3 Hedging using futures
      4. 41.4 The margin process
      5. Appendices
      6. Questions and exercises
    5. 42: Options I
      1. 42.1 Introduction
      2. 42.2 Option instruments
      3. 42.3 Options and payoff profiles
      4. 42.4 Option pricing parameters
      5. Appendices
      6. Questions and exercises
    6. 43: The Dynamics of Asset Prices
      1. 43.1 The behaviour of asset prices
      2. 43.2 Stochastic calculus models: Brownian motion and Itô calculus
      3. 43.3 Perfect capital markets
      4. Appendices
      5. Questions and exercises
    7. 44: Options II: Pricing and Valuation
      1. 44.1 Option pricing
      2. 44.2 Pricing derivative securities
      3. 44.3 Simulation methods
      4. 44.4 Valuation of bond options
      5. 44.5 Interest-rate options and the Black model
      6. 44.6 Critique of the Black–Scholes model
      7. 44.7 The Barone-Adesi and Whaley model
      8. 44.8 Valuation of American options
      9. 44.9 Describing stochastic volatilities
      10. 44.10 A final word on (and summary of) the models
      11. Appendices
      12. Questions and exercises
    8. 45: Options III: The Binomial Pricing Model
      1. 45.1 The binomial option pricing model
      2. 45.2 The binomial approach for interest-rate options
      3. 45.3 Comparison with B–S model
      4. Appendices
    9. 46: Options IV: Pricing Models for Bond Options
      1. 46.1 Introduction
      2. 46.2 Pricing bond options
      3. 46.3 Using option models to price corporate bonds1
      4. Appendices
      5. Questions and exercises
    10. 47: Options V – Managing an Option Book
      1. 47.1 Behaviour of option prices
      2. 47.2 Measuring option risk: The Greeks
      3. 47.3 The option smile
      4. Appendices
      5. Questions and exercises
    11. 48: Options VI: Strategies and Uses
      1. 48.1 Introduction
      2. 48.2 Spreads
      3. 48.3 Volatility trades
      4. 48.4 Collars, caps and floors
      5. 48.5 Using options in bond markets
      6. Appendices
      7. Questions and exercises
    12. 49: Options VII: Exotic Options
      1. 49.1 Options with modified contract terms
      2. 49.2 Path-dependent options
      3. 49.3 Multi-asset options
      4. 49.4 Pricing and hedging exotic options
      5. 49.5 Using exotic options: case studies
      6. Questions and exercises
  15. Part VII: Approaches to Trading and Hedging
    1. Introduction
    2. 50: Approaches to Trading and Hedging
      1. 50.1 Futures trading
      2. 50.2 Yield curves and relative value
      3. 50.3 Yield spread trades
      4. 50.4 Hedging bond positions
      5. 50.5 Introduction to bond analysis using spot rates and forward rates in continuous time
      6. Appendices
      7. Questions and exercises
  16. Part VIII: Advanced Fixed Income Analytics
    1. Introduction
      1. Introduction
      2. The dynamics of the yield curve
      3. Factors influencing the yield curve
      4. Approaches to modelling
      5. Mathematics primer
    2. 51: Interest-rate Models I
      1. 51.1 Introduction
      2. 51.2 Interest-rate processes
      3. 51.3 One-factor models
      4. 51.4 Arbitrage-free models
      5. 51.5 Fitting the model
      6. 51.6 Summary
      7. Questions and exercises
    3. 52: Interest-rate Models II
      1. 52.1 Introduction
      2. 52.2 The Heath–Jarrow–Morton model
      3. 52.3 Multi-factor term structure models
      4. 52.4 Assessing one-factor and multi-factor models
      5. Questions and exercises
    4. 53: Estimating and Fitting the Term Structure
      1. 53.1 Introduction
      2. 53.2 Bond market information
      3. 53.3 Curve-fitting techniques: parametric
      4. 53.4 The cubic spline method for estimating and fitting the yield curve
      5. 53.5 The Anderson–Sleath evaluation
      6. Appendices
      7. Questions and exercises
    5. 54: Advanced Analytics for Index-Linked Bonds
      1. 54.1 Index-linked bonds and real yields
      2. 54.2 Duration and index-linked bonds
      3. 54.3 Estimating the real term structure of interest rates
      4. Questions and exercises
    6. 55: Analysing the Long Bond Yield
      1. 55.1 Theories of long-dated bond yields
      2. 55.2 Pricing a long bond
      3. 55.3 Further views on the long-dated bond yield
      4. 55.4 Analysing the convexity bias in long-bond yields
    7. 56: The Default Risk of Corporate Bonds
      1. 56.1 Corporate bond default spread risk
      2. 56.2 Default risk and default spreads
  17. Part IX: Portfolio Management
    1. Introduction
    2. 57: Portfolio Management I
      1. 57.1 Generic portfolio management
      2. 57.2 Active bond portfolio management
      3. Appendices
      4. Questions and exercises
    3. 58: Portfolio Management II
      1. 58.1 Overview
      2. 58.2 Structured portfolio strategies
      3. 58.3 Immunisation
      4. 58.4 Extending traditional immunisation theory
      5. 58.5 Multiple liabilities immunisation
      6. Questions and exercises
    4. 59: Portfolio Management III
      1. 59.1 Introduction
      2. 59.2 Performance evaluation
      3. Questions and exercises
    5. 60: Portfolio Yield Measurement
      1. 60.1 Portfolio yield
      2. 60.2 Value-weighted portfolio yield
    6. 61: Bond Indices
      1. 61.1 Overview
      2. 61.2 Maturity of an index
      3. 61.3 Responding to events
      4. 61.4 Composition of the index
      5. 61.5 Calculation of index value
      6. Appendices
    7. 62: International Investment
      1. 62.1 Arguments for investing in international bonds
      2. 62.2 International portfolio management
  18. Part X: Technical Analysis
    1. Introduction
    2. 63: Technical Analysis
      1. 63.1 Introduction
      2. 63.2 Trading market profile
      3. 63.3 Dow theory
      4. 63.4 Chart construction
      5. 63.5 Trend analysis
      6. 63.6 Reversal patterns
      7. 63.7 Continuation patterns
      8. 63.8 Point and figure charting
      9. 63.9 Mathematical approaches
      10. 63.10 Contrary opinion theory
      11. 63.11 Volume and open interest
      12. 63.12 Candlestick charting
      13. 63.13 Elliott wave theory
      14. 63.14 Stop losses
      15. 63.15 Concluding remarks
      16. Questions and exercises
  19. Part XI: Introduction to Credit Derivatives
    1. Introduction
    2. 64: Introduction to Credit Derivatives
      1. 64.1 Overview
      2. 64.2 Pricing
      3. 64.3 Regulatory issues
      4. Appendices
    3. 65: Credit Derivatives II
      1. 65.1 Theoretical pricing models
      2. 65.2 Credit spread options
      3. 65.3 Default options pricing
    4. 66: Credit Derivatives III: Instruments and Applications
      1. 66.1 Credit default swaps
      2. 66.2 Total return swap
      3. 66.3 Credit options
      4. 66.4 Credit-linked notes
      5. 66.5 Applications
  20. Part XII: Emerging Bond Markets
    1. Introduction
    2. 67: Emerging Bond Markets and Brady Bonds
      1. 67.1 Overview
      2. 67.2 Key features
      3. 67.3 Trading in the emerging bond markets
      4. 67.4 Brady bonds
      5. Appendices
    3. 68: Emerging Bond Markets II
      1. 68.1 Analysing of relative value
      2. 68.2 Selected emerging bond markets
  21. Concluding Remarks
    1. Developments in finance
    2. Debt markets and the Internet
    3. The importance of government debt
  22. Glossary
  23. Index