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BOND MATH: The Theory Behind the Formulas by Donald J. Smith

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The Story of TIGRS, CATS, LIONS, and STRIPS

Financial engineering can be defined as the creation of a security having a risk-return profile that is otherwise unavailable. The creation of U.S. Treasury STRIPS is a classic example. The story starts in the early 1980s, when interest rates were high due to double-digit inflation rates. When rates later dropped, the descent was steep and dramatic. For example, yields on 10-year Treasury notes averaged 14.30% during the month of June 1982 and fell to 10.85% by June 1983. Treasury yields then rose and averaged 13.56% for June 1984 before another descent to 10.16% in June 1985 and farther down to 7.80% for June 1986. Figure 2.1 displays the monthly averages of daily 10-year Treasury yields from April ...

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