Fixed Income Relative Value Analysis: A Practitioners Guide to the Theory, Tools, and Trades

Chapter 11

Fitted Bond Curves

Introduction

Which of an issuer’s bonds are rich, and which are cheap? And how do we know? To answer these questions, we first need to better define the terms rich and cheap in this context.

Not surprisingly given that our subject matter is relative value, we’ll define these words in relative terms rather than in absolute terms. In particular, we say that a bond is rich if its price is greater than we’d expect conditional on the available information, including but not limited to the prices of the issuer’s other bonds. Other information might include whether the bond is special in the repo market, whether the bond is deliverable into a futures contract, and the liquidity of the bond as proxied by the bid–ask spread. ...