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Fixed Income Markets: Management, Trading and Hedging, 2nd Edition

by Moorad Choudhry, David Moskovic, Max Wong

September 2014

Beginner

640 pages

22h 53m

English

Wiley

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Foreword
Preface
Acknowledgments
About the Authors
PART ONE Introduction to Bonds
CHAPTER 1 The Bond Instrument
Bond-Market Basics Capital Market Participants Investors World Bond Markets Overview of the Main Bond Markets Time Value of Money Bond Pricing and Yield: The Traditional Approach Bond Yield Selected Bibliography and References Notes
CHAPTER 2 Bond Instruments and Interest-Rate Risk
Duration, Modified Duration, and Convexity Appendices Appendix 2.1 Formal Derivation of Modified-Duration Measure Appendix 2.2 Measuring Convexity Appendix 2.3 Taylor Expansion of the Price/Yield Function Selected Bibliography and References Notes
CHAPTER 3 Bond Pricing, Spot, and Forward Rates
Basic Concepts Coupon Bonds Bond Price in Continuous Time Forward Rates Term Structure Hypotheses Evidence on the Expectations Hypothesis Appendices Appendix 3.1 The Integral Appendix 3.2 The Derivation of the Bond Price Equation in Continuous Time Notes Selected Bibliography and References
CHAPTER 4 Interest-Rate Modelling
Background One-Factor Term-Structure Models Choosing a Term-Structure Model Appendix Appendix 4.1 Geometric Brownian Motion Notes Selected Bibliography and References
CHAPTER 5 Fitting the Yield Curve
Yield-Curve Smoothing Non-parametric Methods Comparing Curves Yield Curve Construction: A Practical Guide Appendices Appendix 5.1 Linear Regression: Ordinary Least Squares Appendix 5.2 Regression Splines Notes Selected Bibliography and References
PART TWO Selected Market Instruments

CHAPTER 6 The Money Markets
Overview Securities Quoted on a Yield Basis The Repo Instrument Money-Market Derivatives Short-Term Interest-Rate Futures Appendices Appendix 6.1 Notes Selected Bibliography and References
CHAPTER 7 Hybrid Securities and Structured Securities
Floating-Rate Notes Indexed Amortising Note Synthetic Convertible Note Interest-Differential Notes Convertible Bonds Contingent Convertible Securities References
CHAPTER 8 Bonds with Embedded Options and Option-Adjusted Spread Analysis
Understanding Embedded-Option Elements in a Bond The Binomial Tree of Short-Term Interest Rates Price Volatility of Bonds with Embedded Options Correct Way to Risk-Manage a Callable Note Appendices Appendix 8.1 Calculating Interest Rate Paths Using Microsoft Excel Notes Selected Bibliography and References
CHAPTER 9 Inflation-Indexed Bonds and Derivatives
Basic Concepts Index-Linked Bond Yields Inflation-Indexed Derivatives Applications Appendices Appendix 9.1 Current Issuers of Public-Sector Indexed Securities Appendix 9.2 U.S. Treasury Inflation-Indexed Securities (TIPS) Notes Selected Bibliography and References
CHAPTER 10 Introduction to Securitisation and Asset-Backed Securities
The Concept of Securitisation The Process of Securitisation Securitising Mortgages ABS Structures: A Primer on Performance Metrics and Test Measures The Securitisation Market Post-2007 Special Purpose Vehicles (SPVs) Summary and Conclusions Notes Selected Bibliography and References
PART THREE Derivative Instruments
Recommended Reading
CHAPTER 11 Forwards and Futures Valuation
Introduction Forwards Futures Forwards and Futures Cash Flow Differences Relationship between Forward and Future Price The Forward-Spot Parity The Basis and Implied Repo Rate Notes Selected Bibliography and References
CHAPTER 12 Bond Futures Contracts
Background Bond Futures Contracts Futures Pricing Hedging Using Futures The Margin Process Appendix Appendix 12.1 The Conversion Factor for the Long Gilt Future Notes Selected Bibliography and References
CHAPTER 13 Swaps
Interest-Rate Swaps Generic Swap Valuation Asset Swaps An Overview of Interest-Rate Swap Applications Bloomberg Screens Appendix Appendix 13.1 Calculating Futures Strip Rates and Implied Swap Rates Notes Selected Bibliography and References
CHAPTER 14 Credit Derivatives I: Instruments and Applications
Credit Risk Credit Risk and Credit Derivatives Applications Credit Event Credit Derivative Instruments Credit-Linked Notes Sidebar: Uncollateralised CDS The iTraxx Index Note Applications for Portfolio Managers Risks in Credit Default Swaps Big Bang in CDS Conclusion Appendix Appendix 14.1 Bond Credit Ratings Notes Selected Bibliography and References
CHAPTER 15 Credit Derivatives II: Pricing, Valuation, and the Basis
Introduction Asset Swap Pricing Pricing Models Notes Selected Bibliography and References
CHAPTER 16 Options I
Background Option Instruments Option Pricing: Setting the Scene Option Pricing The Black-Scholes Option Model Interest-Rate Options and the Black Model Comment on the Black-Scholes Model A Final Word on Option Models Appendices Appendix 16.2 Lognormal Distribution of Returns Appendix 16.3 Black-Scholes Model in Microsoft Excel Notes Selected Bibliography and References
CHAPTER 17 Options II
Behaviour of Option Prices Assessing Time Value American Options Measuring Option Risk: The Greeks Delta Gamma Theta Vega Rho Lambda The Option Smile Notes Selected Bibliography and References
PART FOUR Bond Trading and Hedging
CHAPTER 18 Value-at-Risk and Credit VaR
Introducing Value-at-Risk Explaining Value-at-Risk Value-at-Risk for Fixed-Income Derivative Instruments Stress Testing Value-at-Risk Methodology for Credit Risk Appendix 18.1 Assumption of Normality Notes Selected Bibliography and References
CHAPTER 19 Government Bond Analysis, the Yield Curve, and Relative-Value Trading
The Determinants of Yield Practical Uses of Redemption Yield and Duration Implied Spot Rates and Market Zero-Coupon Yields Yield-Spread Trades Coupon Spread Butterfly Trades Case Study: Spread Trade Notes Selected Bibliography and References
CHAPTER 20 Approaches to Trading and Hedging
Futures Trading Yield Curves and Relative Value Yield-Spread Trades Hedging Bond Positions Bond Analysis Using Spot Rates and Forward Rates in Continuous Time Bond Prices as a Function of Spot and Forward Rates Appendices Appendix 20.1 Summary of Derivation of Optimum Hedge Equation Appendix 20.2 Forward-Rate Structure in Conventional Yield-Curve Environment Notes Selected Bibliography
CHAPTER 21 Derivatives Risk Management: Convexity, Collateral, and Correlation
Abstract Why Correlation Occurs in the Markets Correlation and Causation How Can We Define Correlation? Measuring Correlation Correlation Swaps, Pricing, and Their Risks Quantos, Pricing, and their Risks Differences between Instantaneous and Terminal Volatilities and Correlations Hedging a Portfolio of Correlation Swaps and Quantos Uncollateralised Derivatives and Note Discounting Explanation of the Risk-Neutral Measure What Does Discounting Really Represent? Pricing an Uncollateralised Cash Flow Graph of PV from Different CSAs Senior Unsecured Bonds: Equivalence to Uncollateralised Derivatives Funding a Trading Book A Diversion: St. Petersburg Paradox and Credit Risk Making Money for Whom? Chapter Summary
APPENDIX A Statistical Concepts
Mean and Standard Deviation
APPENDIX B Basic Tools
Summation and Product Operators Standard Brownian Motion and the Dynamics of the Asset-Price Process The Integral Calculus Stochastic Integrals
APPENDIX C Introduction to the Mathematics of Fixed-Income Pricing
Bond Pricing Yield to Maturity (YTM) Expectation Hypothesis Notes References
APPENDIX D About the Companion Website
Description of the Content
Glossary
Index
End User License Agreement

Content preview from Fixed Income Markets: Management, Trading and Hedging, 2nd Edition

CHAPTER 11 Forwards and Futures Valuation

Before our discussion of derivative instruments, we discuss the valuation and analysis of forward and futures contracts. A description of interest-rate futures was given in Chapter 6. Here we develop basic valuation concepts.

INTRODUCTION

A forward contract is an agreement between two parties in which the buyer contracts to purchase from the seller a specified asset, for delivery at a future date, at a price agreed today. The terms are set so that the present value of the contract is zero. For the forthcoming analysis, we use the following notation:

P is the current price of the underlying asset, also known as the spot price
P_T is the price of the underlying asset at the time of delivery
X is the delivery price of the forward contract
T is the term to maturity of the contract in years, also referred to as the time-to-delivery
r is the risk-free interest rate
R is the return of the payout or its yield
F is the current price of the forward contract

The payoff of a forward contract is therefore given by

(11.1)

with X set at the start so that the present value of (P_T – X) is zero. The payout yield is calculated by obtaining the percentage of the spot price that is paid out on expiry.

FORWARDS

When a forward contract is written, its delivery price is set so that the present value of the payout is zero. This means that the forward ...

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