Foundations of Computational Finance with MATLAB

CHAPTER 6Bonds

6.1 Introduction

If you need a sense of the bond market's importance in finance, consider political consultant James Carville's comment from the early 1990s. To paraphrase, Carville said that if reincarnation existed, he previously wanted to come back as the president or the pope or a .400 baseball hitter. But after experiencing the bond market's influence on the economy and politics, he changed his mind and decided he wanted to come back as the bond market because it could intimidate everyone.

The bond or fixed income market consists of numerous US and foreign debt submarkets including governments, government agencies, corporations, and municipalities. It's an enormous market: According to the Securities Industry and Financial Markets Association's (SIFMA) 2017 Fact Book, global bond markets' outstanding value increased to $92.2 trillion in 2015. That amount is larger than global equity market capitalization, which increased to $70.0 trillion from $67.1 trillion in 2015.¹

Stock and commodity prices often capture more headlines, but investors in all markets monitor bond yields closely, particularly key interest rate indicators like the US Treasury 10-year yield and announcements from central banks. Changes in interest rates and forecasts of future rates have a large influence on financial markets. On an everyday level, they influence what consumers earn on savings and pay for loans.

This chapter expands the time-value-of-money material in the previous chapter ...