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Financial Engineering: The Evolution of a Profession by Cara M. Marshall, Tanya Beder

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Chapter 4

The Fixed Income Market

Peruvemba Satish

Allstate Investments, LLC

Fixed Income Market Snapshot

History: The interest rate derivatives markets began to develop in the late 1970s. Early on, the instruments that were traded were mainly used for risk management purposes by corporations exposed to interest rate fluctuations. However, the instruments were soon applied by other types of users for their hedging and investment needs. Eventually, the early derivatives led to the development of more complex, structured financial products. For these reasons, interest rate derivatives eventually became the largest segment, by far, of the global derivatives markets.

Size: The interest rate market is the largest component of both over-the-counter (OTC) and exchange-traded derivatives. The size of the OTC interest rate derivatives market has grown from $50 trillion at the end of 1998 to about $449 trillion at the end of 2009, while the exchange-traded derivatives side has evolved from $12.6 trillion in 1998 to $67 trillion in 2009.

Products: Over-the-counter products include interest rate swaps (either fixed-for-fixed or fixed-or-floating swaps), caps, floors, collars, corridors, swaptions, warrants, forward rate agreements (FRAs), and bond options. Exchange-traded instruments consist of a variety of interest rate futures on Treasury bonds and bills, Federal Funds, Eurodollars, and EuroYen.

First Usage: In 1975, the Chicago Board of Trade created the first interest rate futures contract ...

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