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Handbook of Finance: Financial Markets and Instruments

Name: Handbook of Finance: Financial Markets and Instruments
Author: Frank J. Fabozzi
ISBN: 9780470078143

by Frank J. Fabozzi

August 2008

Beginner

852 pages

46h 4m

English

Wiley

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Copyright
About the Editor
Contributors
Preface
TOPIC CATEGORIES
Guide to the Handbook Handbook of Finance
ORGANIZATIONTABLE OF CONTENTSINDEXCHAPTERS
1. Market Players andMarkets
1. Overview of Financial Instruments and Financial Markets
1.1. ISSUERS AND INVESTORS1.2. DEBT VERSUS EQUITY INSTRUMENTS1.3. CHARACTERISTICS OF DEBT INSTRUMENTS1.3.1. Maturity1.3.2. Par Value1.3.3. Coupon Rate1.3.4. Provisions for Paying off Debt Instruments1.3.5. Options Granted to Bondholders1.4. FINANCIAL MARKETS1.4.1. Role of Financial Markets1.4.2. Classification of Financial Markets1.5. DERIVATIVE MARKETS1.5.1. Types of Derivative Instruments1.6. SUMMARY1.7. REFERENCES
2. Fundamentals of Investing
2.1. SETTING INVESTMENT OBJECTIVES2.2. ESTABLISHING AN INVESTMENT POLICY2.2.1. Asset Classes2.2.2. Risks Associated with Investing2.3. SELECTING A PORTFOLIO STRATEGY2.4. CONSTRUCTING THE PORTFOLIO2.4.1. Constructing an Indexed Portfolio2.4.2. Constructing an Active Portfolio2.5. EVALUATING PERFORMANCE2.6. SUMMARY2.7. REFERENCES
3. The American Banking System
3.1. GLOBAL BANKING CONSTANTS3.2. STRUCTURE OF THE POST-DEPRESSION BANKING SECTOR3.2.1. Features of the "Old Structure" Still in Place3.2.2. Product Constraints in American Banking3.2.3. Geographic Constraints in American Banking3.2.4. Interest Rate Ceilings on Bank Deposits3.2.5. Reserve Requirements3.2.6. Relationship Banking3.3. FORCES FOR CHANGE IN AMERICAN BANKING IN THE 1980s AND 1990s3.3.1. External Competition3.3.2. Volatility, Risk, and Failure3.4. DEREGULATION, REREGULATION, AND TODAY'S EVOLVING BANKING SYSTEM3.4.1. Deposit Deregulation3.4.2. Risk-Based Capital Standards3.4.3. Technological Progress and Bank Developments3.4.4. Product Deregulation3.4.5. Geographic Deregulation3.4.6. Results of Geographic Deregulation3.5. THE AMERICAN BANKING SYSTEM WILL CONTINUE TO BE UNIQUE3.5.1. The Outlook for Dual Banking3.5.2. Continued Technological Advances in Risk Control3.5.3. The Future U.S. Regulatory Structure3.5.4. The Continued Separation of Depositories from Nonfinancial Firms3.6. SUMMARY3.7. REFERENCES
4. Monetary Policy: How the Fed Sets, Implements, and Measures Policy Choices
4.1. KEY ECONOMIC INFLUENCES ON FED POLICY4.2. IMPLEMENTING MONETARY POLICY: THE TRANSMISSION PROCESS4.3. THE IMPACT OF MONETARY POLICY: ITS DECLINING DIRECT INFLUENCE4.4. GLOBAL CREDIBILITY: THE CENTRAL BANKER'S RESPONSIBILITY4.5. SUMMARY4.6. REFERENCES

5. Institutional Aspects of the Securities Markets
5.1. THE STOCK MARKET EFFICIENCY QUESTION5.2. SOME HISTORY5.3. THE ROLE OF FINANCIAL INFORMATION IN THE MARKET EFFICIENCY QUESTION5.4. THE ROLE OF ORGANIZED MARKETS IN THE MARKET EFFICIENCY QUESTION5.5. THE ROLE OF TRADING IN THE MARKET EFFICIENCY QUESTION5.6. THE ROLE OF SECURITIES MARKET REGULATION IN THE MARKET EFFICIENCY QUESTION5.7. THE ROLE OF STOCK MARKET INDICATORS IN THE MARKET EFFICIENCY QUESTION5.8. SUMMARY5.9. REFERENCES
6. Investment Banking
6.1. TYPES OF INVESTMENT BANKS6.1.1. Financial Holding Companies6.1.2. Full-Service Investment Banks6.1.3. Boutique Investment Banks6.2. INVESTMENT BANKING BUSINESS6.2.1. Investment Banking6.2.2. Trading and Principal Investments6.2.3. Asset Management and Securities Services6.3. TRENDS AND CHALLENGES6.3.1. The Evolving Investment Banking Markets6.3.2. Challenges and Opportunities6.3.3. Success Factors6.4. SUMMARY6.5. REFERENCES
7. Securities Innovation
7.1. DEBT INNOVATIONS7.1.1. Risk Reallocation7.1.2. Enhanced Liquidity7.1.3. Reductions in Agency Costs7.1.4. Reductions in Transaction Costs7.1.5. Reductions in Taxes7.1.6. Circumvention of Regulatory Restrictions or Other Constraints7.2. STRUCTURED PRODUCTS7.2.1. What Structured Products Are Designed to Achieve7.2.2. Taking a View on Interest Rates7.2.3. Transferring Default Risk7.3. HYBRID CAPITAL SECURITIES7.3.1. Trust Preferred Hybrid Capital Securities7.3.2. Newer Hybrid Structures7.3.3. Substituting Debt for Equity7.4. PREFERRED STOCK INNOVATIONS7.4.1. Managing Interest Rate Risk with Preferred Stock7.4.2. More Desirable Pattern of Cash Flows7.4.3. Other Preferred Stock Innovations7.5. CONVERTIBLE SECURITIES INNOVATIONS7.5.1. Reallocation of Investment Risk/More Desirable Pattern of Cash Flows7.5.2. Reductions in Taxes7.5.3. Reductions in Agency Costs7.5.4. Reductions in Transaction Costs7.5.5. Satisfying Regulatory Restrictions7.5.6. Example of a Securities Innovation that Solved a Difficult Corporate Finance Problem7.5.7. Dividend Policy7.6. COMMON EQUITY INNOVATIONS7.6.1. Reallocation of Investment Risk7.6.2. Reductions in Agency Costs7.6.3. Reductions in Taxes7.7. SUMMARY7.8. REFERENCES
8. An Arbitrage Perspective of the Purpose and Structure of Financial Markets
8.1. RISK SHARING8.2. STRUCTURE OF FINANCIAL MARKETS8.3. ARBITRAGE: PURE VERSUS RELATIVE8.4. FINANCIAL INSTITUTIONS: ASSET TRANSFORMERS AND BROKER-DEALERS8.5. PRIMARY AND SECONDARY MARKETS8.6. MARKET PLAYERS: HEDGERS VERSUS SPECULATORS8.7. SUMMARY8.8. REFERENCES
9. Complete Markets
9.1. ECONOMIC ORIGINS OF COMPLETE MARKETS9.2. COMPLETE MARKETS IN FINANCE9.3. SECURITIES PRICING IN COMPLETE MARKETS9.4. PRICE INFORMATION IN COMPLETE MARKETS9.5. MISSING MARKETS AND FINANCIAL INNOVATION9.6. THE MEAN-VARIANCE THEORY IN COMPLETE MARKETS9.7. SUMMARY9.8. REFERENCES
10. Introduction to Islamic Finance
10.1. WHAT IS ISLAMIC FINANCE?10.2. PROHIBITIONS AND THEIR IMPLICATIONS10.2.1. Riba10.2.2. Ina versus Murabaha10.2.3. Gharar10.2.4. Forwards and Insurance10.3. NOMINATE CONTRACTS: FROM BASIC BUILDING BLOCKS TO COMPLEX STRUCTURES10.3.1. Murabaha10.3.2. Ina and Tawarruq10.3.3. Securitization and Ijara10.3.4. Sukuk10.3.5. Partnerships: Musharaka and Mudaraba10.3.6. Benchmarking to LIBOR10.3.7. Short-Term Sukuk and Salam10.3.8. Parallel Salam10.3.9. Miscellaneous Structures10.3.10. Derivatives10.3.11. The First U.S. Sukuk10.4. SUMMARY10.5. REFERENCES
2. Common Stock
11. The U.S. Equity Markets
11.1. EXCHANGE MARKET STRUCTURES11.1.1. Order-Driven Markets11.1.2. Quote-Driven Markets11.1.3. Order-Driven versus Quote-Driven Markets11.2. CHANGES IN EXCHANGE OWNERSHIP AND TRADING STRUCTURES11.3. THE U.S. STOCK MARKETS: EXCHANGES AND OTC MARKETS11.3.1. National Exchanges11.3.2. Nasdaq Stock Market: The OTC Market11.3.3. Other OTC Markets11.3.4. Options Markets11.3.5. Other Stock Exchange Markets11.4. OFF-EXCHANGE MARKETS/ALTERNATIVE ELECTRONIC MARKETS11.4.1. Electronic Communications Networks11.4.2. Alternative Trading Systems11.5. THE CURRENT NYSE STOCK MARKET11.5.1. Background11.5.2. The Prelude to the NYSE Hybrid Market11.5.3. The NYSE Hybrid Market11.5.4. Impact of the NYSE Hybrid Market11.5.5. Euronext NV11.5.6. American Stock Exchange11.6. EVOLVING STOCK MARKET PRACTICES11.6.1. Order-Handling Rules11.6.2. Smart Order Routers11.6.3. SEC Regulation NMS11.6.4. Internalization11.6.5. Alternative Display Facility11.6.6. Trade-Reporting Facility11.6.7. Direct Market Access11.6.8. Algorithmic Trading11.7. BASIC FUNCTIONING OF STOCK MARKETS11.7.1. Price Reporting11.7.2. Regulation11.7.3. Clearance and Settlement11.7.4. Tick Size11.7.5. Short-Selling Rules11.7.6. Block Trades11.7.7. Commissions11.8. SUMMARY11.9. APPENDIX: KEY DATES11.10. ACKNOWLEDGMENTS11.11. REFERENCES
12. The Information Content of Short Sales
12.1. SHORT SALES: REPORTING, FREQUENCY, AND CONSTRAINTS12.2. ACADEMIC THEORY VERSUS THE TECHNICAL ANALYST'S VIEW12.3. THE EMPIRICAL EVIDENCE12.3.1. Predicting Short-Term Returns with Short Interest: The Early Evidence12.3.2. Predicting Short-Term Returns with and without Hedging and Traded Options12.3.3. Predicting Long-Term Returns with Short Interest12.3.4. Determinants of Short Interest: Strategies, Profitability, and Information Content12.3.5. The Costs of Short Selling as Limits to Arbitrage12.3.6. Short-Sales Transactions and the Implications of More Frequent Reporting12.4. SOME PRACTICAL IMPLICATIONS12.5. SUMMARY12.6. REFERENCES
13. Emerging Stock Market Investment
13.1. ECONOMIES IN TRANSITION13.1.1. Emerging Market Countries13.1.2. The Process of Emergence13.1.3. Why the Process Will Continue13.1.4. Why Progress Is Uneven13.2. INVESTMENT CHARACTERISTICS13.2.1. Factors Favoring Higher Returns13.2.2. Factors Favoring Lower Portfolio Risks13.2.3. Implementation Obstacles13.3. INVESTMENT APPROACH13.3.1. Investment Strategies13.4. RELATED RESEARCH13.5. SUMMARY13.6. REFERENCES
14. Listed Equity Options and Futures
14.1. LISTED EQUITY OPTIONS14.1.1. Basic Features of Listed Options14.2. EQUITY FUTURES CONTRACTS14.2.1. Stock Index Futures Contracts14.2.2. Single-Stock Futures14.3. SUMMARY14.4. REFERENCES
15. OTC Equity Derivatives
15.1. PRODUCT FUNDAMENTALS AND APPLICATIONS15.2. OTC OPTIONS AND WARRANTS15.2.1. First-Generation OTC Options15.2.2. Exotics: Second-Generation OTC Options15.2.3. Using Exotics15.3. EQUITY-LINKED DEBT INVESTMENTS15.4. EQUITY SWAPS15.5. SUMMARY15.6. REFERENCES
16. Volatility Derivatives
16.1. REALIZED VOLATILITY DERIVATIVE CONTRACTS16.1.1. Illustration of the Computation of the Settlement Price of a Realized Volatility Swap16.1.2. CBOE Futures Exchange Realized Volatility Futures Contract16.1.3. Volatility versus Variance Contracts16.1.4. Expected Return/Risk Management Applications16.2. IMPLIED VOLATILITY DERIVATIVES CONTRACTS16.2.1. Illustration of How to Estimate VIX Futures Price16.2.2. Expected Return/Risk Management Applications16.2.3. CBOE VIX Options16.3. SUMMARY16.4. APPENDIX: CONSTRUCTION OF THE CBOE'S MARKET VOLATILITY INDEX (VIX)16.5. REFERENCES
3. Fixed Income Instruments
17. Bonds: Investment Features and Risks
17.1. SECTORS OF THE BOND MARKET17.2. FEATURES OF BONDS17.2.1. Maturity17.2.2. Par Value17.2.3. Coupon Rate17.2.4. Accrued Interest17.2.5. Provisions for Paying Off Bonds17.2.6. Options Granted to Bondholders17.2.7. Currency Denomination17.3. YIELD MEASURES17.3.1. Current Yield17.3.2. Yield to Maturity17.3.3. Yield to Call17.3.4. Yield to Put17.3.5. Yield to Worst17.3.6. Cash Flow Yield17.4. RISKS ASSOCIATED WITH INVESTING IN BONDS17.4.1. Interest Rate Risk17.4.2. Call and Prepayment Risk17.4.3. Credit Risk17.4.4. Liquidity Risk17.4.5. Exchange Rate or Currency Risk17.4.6. Inflation or Purchasing Power Risk17.5. SUMMARY17.6. REFERENCES
18. Residential Mortgages
18.1. OVERVIEW OF MORTGAGES18.1.1. Key Attributes that Define Mortgages18.1.2. Prepayments and Prepayment Penalties18.2. MORTGAGE LOAN MECHANICS18.3. RISKS ASSOCIATED WITH MORTGAGES AND MORTGAGE PRODUCTS18.3.1. Prepayment Risk18.3.2. Credit and Default Risk18.4. SUMMARY18.5. REFERENCES
19. Reverse Mortgages
19.1. HOW A REVERSE MORTGAGE WORKS19.2. PROGRAMS19.2.1. HECM Program19.2.2. Fannie Mae Home Keeper19.2.3. Proprietary Products19.3. SUMMARY19.4. REFERENCES
20. U.S. Treasury Securities
20.1. TYPES OF MARKETABLE TREASURY SECURITIES20.1.1. Fixed-Principal Treasury Securities20.2. TREASURY AUCTION PROCESS20.3. SECONDARY MARKET20.3.1. Price Quotes for Treasury Bills20.3.2. Quotes on Treasury Coupon Securities20.4. STRIPPED TREASURY SECURITIES20.5. SUMMARY20.6. REFERENCES
21. Federal Agency Securities
21.1. FEDERALLY RELATED INSTITUTIONS21.1.1. Tennessee Valley Authority21.2. GOVERNMENT-SPONSORED ENTERPRISES21.2.1. Types and Features of GSE Securities21.2.2. Programmatic GSE Issuance Platforms21.2.3. Description of GSEs and Securities Issued21.2.4. Fannie Mae21.2.5. Freddie Mac21.2.6. Federal Home Loan Bank System (FHL Banks)21.2.7. The Federal Agricultural Mortgage Corporation (Farmer Mac)21.2.8. Federal Farm Credit Bank System (Farm Credit)21.2.9. Sallie Mae21.2.10. Financing Corporation (FICO)21.2.11. Resolution Trust Corporation (REFCORP)21.2.12. Farm Credit Financial Assistance Corporation (FACO)21.2.13. Repo Transactions Market in GSE Debt Collateral21.2.14. Credit Risk21.2.15. Yield Spreads21.3. SUMMARY21.4. REFERENCES
22. Municipal Securities
22.1. ISSUERS AND ISSUANCE PROCEDURES22.2. TAX-EXEMPT AND TAXABLE MUNICIPAL SECURITIES22.3. TAX PROVISIONS AFFECTING MUNICIPAL SECURITIES22.3.1. Treatment of Original-Issue Discount22.3.2. Alternative Minimum Tax22.3.3. Deductibility of Interest Expense Incurred to Acquire Municipals22.4. TYPES OF MUNICIPAL SECURITIES22.4.1. Tax-Backed Debt22.4.2. Revenue Bonds22.4.3. Special Bond Structures22.5. MUNICIPAL BOND YIELDS22.6. FLOATING-RATE MUNICIPAL SECURITIES22.7. RISKS ASSOCIATED WITH INVESTING IN MUNICIPAL BONDS22.8. SUMMARY22.9. REFERENCES
23. Corporate Fixed Income Securities
23.1. CORPORATE BONDS23.1.1. Secured Debt and Unsecured Debt23.1.2. Provisions for Paying Off Bonds23.1.3. Speculative-Grade Bonds23.1.4. Secondary Market23.1.5. Private-Placement Market for Corporate Bonds23.2. MEDIUM-TERM NOTES23.2.1. Primary Market23.2.2. Structured MTNs23.3. PREFERRED STOCK23.3.1. Tax Treatment of Dividends23.4. SUMMARY23.5. REFERENCES
24. The Eurobond Market
24.1. EUROBONDS24.2. FOREIGN BONDS24.3. EUROBOND INSTRUMENTS24.3.1. Conventional Bonds24.3.2. Floating-Rate Notes24.3.3. Zero-Coupon Bonds24.3.4. Convertible Bonds24.3.5. Eurowarrants24.4. THE ISSUING PROCESS: MARKET PARTICIPANTS24.4.1. The Borrowing Parties24.4.2. The Underwriting Lead Manager24.4.3. The Co-lead Manager24.4.4. Investors24.5. FEES, EXPENSES, AND PRICING24.5.1. Fees24.5.2. Expenses24.5.3. Pricing24.6. ISSUING THE BOND24.6.1. The Gray Market24.6.2. Alternative Issue Procedures24.7. COVENANTS24.7.1. Negative Pledge24.7.2. Disposal of Assets Covenant24.7.3. Gearing Ratio Covenant24.8. TRUST SERVICES24.8.1. Depositary24.8.2. Paying Agent24.8.3. Registrar24.8.4. Trustee24.8.5. Custodian24.8.6. Fiscal Agent24.8.7. Listing Agent24.9. FORM OF THE BOND24.9.1. Temporary Global Note24.9.2. Permanent Global Note24.9.3. Definitive Note24.9.4. Registered Bonds24.10. CLEARING SYSTEMS24.11. SECONDARY MARKET24.12. LEGAL AND TAX ISSUES24.13. EUROBONDS AND SWAP TRANSACTIONS24.14. SETTLEMENT24.15. SUMMARY24.16. REFERENCES
25. The Euro Government Bond Market
25.1. THE EUROZONE: THE FASTEST-GROWING GOVERNMENT BOND MARKET25.1.1. Country Breakdown25.1.2. Maturity Breakdown25.2. EURO GOVERNMENT BOND PRIMARY MARKET25.2.1. Measures to Improve Market Liquidity25.2.2. Bond Auctions: Sizes, Maturities, and Types of Bond25.2.3. Exchange Auctions and Buybacks25.2.4. Other Key Characteristics of the Primary Markets25.3. SECONDARY MARKET AND INTRA-EURO SPREAD DETERMINANTS25.3.1. Sovereign Credit Ratings25.3.2. Other Intra-Euro Bond Spread Drivers25.3.3. Bond Swap Spreads and Their Relationship to Peripheral Spreads25.3.4. Market Volatility as a Spread Driver25.3.5. Other Related Markets25.3.6. Interest Rate Swaps as the Benchmark Curve for Eurozone Government Bonds25.4. SUMMARY25.5. REFERENCES
26. The German Pfandbrief and European Covered Bonds Market
26.1. THE PFANDBRIEF MARKET26.2. HISTORY OF THE PFANDBRIEF26.3. KEY FEATURES OF INVESTOR INTEREST26.3.1. Reduction of Credit Risk26.3.2. Liquidity26.4. MARKET INSTRUMENTS26.4.1. Global Pfandbriefe26.4.2. Structured Pfandbriefe26.4.3. MTN and CP Programs26.4.4. Clearing26.5. KEY DIFFERENCES BETWEEN COVERED BONDS AND ABSs OR MBSs26.6. MARKET PARTICIPANTS26.7. THE CREDIT RATING APPROACH TOWARDS PFANDBRIEFE26.8. THE EUROPEAN COVERED BOND MARKET26.8.1. France26.8.2. Spain26.8.3. Luxembourg26.8.4. Ireland26.9. SUMMARY26.10. REFERENCES
27. Commercial Paper
27.1. CHARACTERISTICS OF COMMERCIAL PAPER27.1.1. Direct Paper versus Dealer Paper27.1.2. The Secondary Market27.2. COMMERCIAL PAPER CREDIT RATINGS27.2.1. Yields on Commercial Paper27.3. ASSET-BACKED COMMERCIAL PAPER27.3.1. Legal Structure27.3.2. Basic Types of ABCP Conduits27.3.3. Credit and Liquidity Enhancement27.3.4. Extendable Note Commercial Paper27.3.5. The ABCP Market Outside the United States27.3.6. Foreign Currency Denominated Commercial Paper27.4. SUMMARY27.5. REFERENCES
28. Money Market Calculations
28.1. DAY COUNT CONVENTIONS28.1.1. Day Count Basis28.1.2. Actual/Actual28.1.3. Actual/36028.1.4. 30/36028.2. DISCOUNT INSTRUMENTS28.2.1. Yield on a Bank Discount Basis28.2.2. CD Equivalent Yield28.2.3. Bond-Equivalent Yield28.3. INTEREST AT MATURITY INSTRUMENTS28.3.1. Converting a CD Yield into a Simple Yield on a 365-Day Basis28.3.2. Converting a Periodic Interest Rate into an Effective Annual Yield28.4. SUMMARY28.5. REFERENCES
29. Convertible Bonds
29.1. CONVERTIBLE BOND MARKET29.2. GENERAL CHARACTERISTICS OF CONVERTIBLE BONDS29.3. ANALYZING CONVERTIBLE SECURITIES: THE TRADITIONAL APPROACH29.3.1. Conversion Value versus Straight Value29.3.2. Market Conversion Price29.3.3. Measuring the Convertible Bond's Income Advantage29.3.4. Measuring the Convertible Bond's Downside Risk29.4. CONVERTIBLE BONDS AS AN INVESTMENT29.5. OTHER TYPES OF CONVERTIBLES29.5.1. Mandatory Convertibles29.5.2. Reverse Convertibles29.6. CONVERTIBLE BOND ARBITRAGE29.7. SUMMARY29.8. REFERENCES
30. Syndicated Loans
30.1. OVERVIEW OF THE SYNDICATED LOAN30.1.1. Types of Syndications30.2. THE SYNDICATION PROCESS30.2.1. The Information Memo or "Bank Book"30.2.2. The Loan Investor Market30.3. PUBLIC VERSUS PRIVATE30.3.1. CREDIT RISK: AN OVERVIEW30.3.2. Default Risk30.3.3. Loss-Given-Default Risk30.4. SYNDICATING A LOAN BY FACILITY30.5. PRICING A LOAN IN THE PRIMARY MARKET30.5.1. Pricing Loans for Bank Investors30.5.2. Pricing Loans for Institutional Players30.6. MARK-TO-MARKET'S EFFECT30.7. TYPES OF SYNDICATED LOAN FACILITIES30.8. SECOND-LIEN LOANS30.9. COVENANT-LITE LOANS30.10. LENDER TITLES30.11. SECONDARY SALES30.11.1. Assignments30.11.2. Primary Assignments30.11.3. Participations30.12. DERIVATIVES—LOAN CREDIT DEFAULT SWAPS30.13. PRICING TERMS30.13.1. Rates30.13.2. Fees30.13.3. Voting Rights30.14. COVENANTS30.15. MANDATORY PREPAYMENTS30.16. COLLATERAL30.16.1. Springing Liens/Collateral Release30.16.2. Change of Control30.16.3. Asset-Based Lending30.16.4. Loan Math: The Art of Spread Calculation30.17. SUMMARY30.18. REFERENCES
31. Emerging Markets Debt
31.1. EMERGING MARKET DEBT INSTRUMENTS31.1.1. Emerging Market External Debt31.1.2. Emerging Market Local Debt31.1.3. Emerging Market Corporate Debt31.1.4. Emerging Market Credit Derivatives31.1.5. Emerging Market Bond Indices31.2. SOVEREIGN CREDIT ANALYSIS31.2.1. Economic Considerations31.2.2. Political Considerations31.2.3. Willingness to Pay31.2.4. Sovereign Credit Perspective31.3. SUMMARY31.4. REFERENCES
32. Introduction to Mortgage-Backed Securities
32.1. CREATING DIFFERENT TYPES OF MBS32.1.1. Agency MBS Creation32.1.2. Private-Label Securitization32.2. MBS TRADING32.2.1. MBS Market Structure32.2.2. Financing and the Dollar Roll Market32.3. CASH FLOW STRUCTURING32.4. SUMMARY32.5. REFERENCES
33. Structuring Collateralized Mortgage Obligations and Interest-Only/ Principal-Only Securities
33.1. NON-CASH-FLOW ASPECTS OF CMOs33.2. COLLATERALIZED MORTGAGE OBLIGATIONS AS RULES33.3. PRINCIPAL-PAY TYPES33.4. INTEREST-PAY TYPES33.5. SEQUENTIAL BONDS33.6. PRO RATA BONDS33.7. SCHEDULED BONDS33.8. SEQUENTIAL PACs AND OTHER COMBINATIONS33.9. INTEREST ONLY AND PRINCIPAL ONLY33.10. SENIOR/SUBORDINATED STRUCTURES33.11. SUMMARY33.12. REFERENCES
34. Commercial Mortgage-Backed Securities
34.1. INVESTMENT CHARACTERISTICS OF TRADITIONAL (CASH) CMBS34.2. BASIC COMMERCIAL LOAN AND CMBS DEAL STRUCTURES34.2.1. Typical Loan Features34.2.2. Cash Flow34.2.3. CMBS Bond Structure34.2.4. Super-Senior and Super-Duper Senior Bonds34.2.5. CMBS Relative Value34.3. RISK CHARACTERISTICS OF COMMERCIAL REAL ESTATE COLLATERAL34.3.1. Property Types34.3.2. Diversification34.3.3. Geography34.3.4. Measurement and Analysis of Diversification34.3.5. Prepayments34.4. STRUCTURAL NUANCES OF CMBSs34.4.1. ARD Loans34.4.2. Appraisal Reduction34.4.3. Servicing and Conflicts of Interest34.4.4. Interest Shortfalls and Recovery of Advances34.4.5. A/B Notes and Mezzanine Loans34.4.6. Additional Debt34.5. SUMMARY34.6. REFERENCES
35. Nonmortgage Asset-Backed Securities
35.1. CREDIT CARD RECEIVABLE-BACKED SECURITIES35.1.1. Cash Flow35.1.2. Performance of the Portfolio of Receivables35.2. EARLY AMORTIZATION TRIGGERS35.3. AUTO LOAN-BACKED SECURITIES35.3.1. Cash Flows and Prepayments35.3.2. Structures35.4. STUDENT LOAN ASSET-BACKED SECURITIES35.4.1. Collateral35.4.2. Structures35.5. SBA LOAN-BACKED SECURITIES35.6. AIRCRAFT LEASE-BACKED SECURITIES35.6.1. Aircraft Leasing35.6.2. Servicing35.6.3. Defaults35.6.4. Enhancement Levels35.7. FRANCHISE LOAN-BACKED SECURITIES35.7.1. Security Characteristics35.7.2. Major Sectors35.7.3. Risk Considerations35.8. RATE REDUCTION BONDS35.8.1. Structure35.8.2. Enhancement Levels35.8.3. Unique Risks35.9. SUMMARY35.10. REFERENCES
36. Synthetic Asset-Backed Securities
36.1. CREDIT DERIVATIVES AND ABS MARKETS36.2. PAY-AS-YOU-GO CDS36.3. MARKET CONSIDERATIONS36.4. ABS CDS AND CASH BOND VALUATION36.5. SUMMARY36.6. REFERENCES
37. Catastrophe Bonds
37.1. CATASTROPHE RISK MANAGEMENT37.1.1. Traditional Reinsurance37.1.2. Catastrophe Risk Layers37.2. CAPITAL MARKET DEVELOPMENTS37.2.1. Government Initiatives37.2.2. Securitization of Catastrophe Risk37.3. STRUCTURE OF CATASTROPHE BONDS37.4. RATING AGENCY AND MODELING CONSIDERATIONS37.4.1. An Uncorrelated Asset Class37.5. MARKET DEVELOPMENTS37.6. MARKET PARTICIPANTS37.7. SUMMARY37.8. ACKNOWLEDGMENTS37.9. REFERENCES
38. Collateralized Debt Obligations
38.1. UNDERSTANDING CDOs38.1.1. Four Attributes of a CDO38.1.2. A CDO Structural Matrix38.1.3. Parties to a CDO38.2. CASH FLOW CDOs38.2.1. Distribution of Cash Flows38.2.2. Restrictions on Management: Safety Nets38.2.3. Credit Ratings38.2.4. Call Provisions in CDO Transactions38.3. SYNTHETIC ARBITRAGE CDOs38.3.1. Full-Capital Structure Synthetic Arbitrage CDOs38.3.2. Single-Tranche CDOs38.3.3. Standard Tranches of CDS Indices38.4. SUMMARY38.5. REFERENCES
39. Interest Rate Futures and Forward Rate Agreements
39.1. SHORT-TERM INTEREST RATE FUTURES CONTRACTS39.1.1. Eurodollar Futures39.1.2. Fed Funds Futures Contract39.2. LONG-TERM INTEREST RATE FUTURES CONTRACTS39.2.1. Treasury Bond Futures39.2.2. Swap Futures Contracts39.2.3. 10-Year Municipal Note Index Futures Contract39.3. FORWARD RATE AGREEMENTS39.3.1. FRA Basics39.3.2. FRA Mechanics39.4. SUMMARY39.5. REFERENCES
40. Interest Rate Swaps
40.1. THE PLAIN VANILLA SWAP40.1.1. Swap Payments versus Cash Flows40.1.2. Swap Quote Conventions40.1.3. Entering Into a Swap and Counterparty Risk40.2. RISK/RETURN CHARACTERISTICS OF AN INTEREST RATE SWAP40.3. INTERPRETING A SWAP POSITION40.3.1. Package of Futures (Forward) Contracts40.3.2. Package of Cash Market Instruments40.4. DESCRIBING THE COUNTERPARTIES TO A SWAP40.5. BEYOND THE PLAIN VANILLA SWAP40.6. SUMMARY40.7. REFERENCES
41. Interest Rate Options and Related Products
41.1. BASIC OPTION CONTRACT41.2. EXCHANGE-TRADED VERSUS OTC OPTIONS41.3. FUTURES OPTIONS41.4. OVER-THE-COUNTER INTEREST RATE OPTIONS41.4.1. Options on a Specific Security41.4.2. Spread Options41.5. COMPOUND OPTIONS41.6. CAPS AND FLOORS41.6.1. Caps41.6.2. Floors41.6.3. Collars41.6.4. Risk and Return Characteristics41.7. SUMMARY41.8. REFERENCES
42. Introduction to Credit Derivatives
42.1. DERIVATIVES: THE BUILDING BLOCK OF CREDIT DERIVATIVES42.2. SECURITIZATION: THE OTHER BUILDING BLOCK42.3. MEANING OF CREDIT DERIVATIVES42.3.1. Quick Guide to Basic Jargon42.3.2. Synthetic Lending42.3.3. Motivations of the Parties42.4. ELEMENTS OF A CREDIT DERIVATIVE42.4.1. Bilateral Deals and Capital Market Deals42.4.2. Reference Asset or Portfolio42.4.3. Structured Portfolio Trade42.4.4. Basket Trades42.4.5. Index-Based Credit Derivative Trades42.4.6. Protection Buyer42.4.7. Protection Seller42.4.8. Funded and Unfunded Credit Derivatives42.4.9. Credit Event42.4.10. Notional Value42.4.11. Premium42.4.12. Tenure42.4.13. Loss Computation42.4.14. Threshold Risk or Loss Materiality Provisions42.4.15. Cash and Physical Settlement42.5. QUICK INTRODUCTION TO THE TYPES OF CREDIT DERIVATIVES42.5.1. Credit Default Swap42.5.2. Total Return Swap42.5.3. Credit-Linked Notes42.5.4. Credit Spread Options42.6. CREDIT DERIVATIVES AND TRADITIONAL FINANCIAL GUARANTEE PRODUCTS42.6.1. Credit Derivatives and Guarantees42.7. CREDIT DERIVATIVES AND SECURITIZATION42.8. SUMMARY42.9. REFERENCES
43. Fixed Income Total Return Swaps
43.1. ECONOMICS OF A TOTAL RETURN SWAP43.1.1. Total Return Swap Compared to an Interest Rate Swap43.1.2. Illustration43.2. APPLICATIONS OF A TOTAL RETURN SWAP43.2.1. Creating a Synthetic Repo43.2.2. Use in the Bank Loan Market43.3. TOTAL RETURN INDEX SWAPS43.3.1. Indexing a Credit Spread Sector by an Active Asset Manager43.3.2. Active Strategies43.3.3. Risk Control43.4. SUMMARY43.5. REFERENCES
44. Bond Market Transparency
44.1. BENEFITS OF AN OPEN SYSTEM44.2. DISPARITY OF MARKET PRICING44.2.1. U.S. Treasury and Agency Securities44.2.2. Corporate Bonds (Investment and Non-Investment Grade)44.2.3. Mortgage-Related Securities44.2.4. Municipals44.2.5. Other44.3. BUYER BEWARE: ALL PRICES ARE NOT CREATED EQUAL44.3.1. Market Indications44.3.2. Matrix Pricing44.3.3. Option-Adjusted Spread Calculation44.4. THE DEBATE ON PRICE TRANSPARENCY44.4.1. Arguments in Favor of Price Transparency44.4.2. Arguments Opposed to Price Transparency44.5. A RAPIDLY EVOLVING MARKET44.5.1. Execution Reporting44.5.2. Best Execution44.5.3. Trading Styles44.6. SUMMARY44.7. REFERENCES
45. Bond Spreads and Relative Value
45.1. BOND SPREADS45.1.1. Swap Spread and Treasury Spread45.1.2. Asset Swap Spread45.1.3. Zero-Volatility Spread45.2. THE ASSET SWAP CDS PRICE45.2.1. Asset Swap Pricing45.2.2. Asset Swap Pricing Example45.2.3. Pricing Differentials45.2.4. Cash-CDS Basis45.3. SUMMARY45.4. REFERENCES
46. The Determinants of the Swap Spread and Understanding the LIBOR Term Premium
46.1. DETERMINANTS OF THE SWAP SPREAD46.1.1. Determinants of the Spread46.2. MAGNITUDE OF THE TERM PREMIUM46.2.1. Illustration46.3. OBSERVATION OF MACRO-LEVEL ECONOMIC AND POLITICAL FACTORS ON SWAP SPREADS46.4. SUMMARY46.5. REFERENCES
4. Real Estate
47. Real Estate Investment
47.1. REAL ESTATE MARKET47.2. KEY CHARACTERISTICS OF REAL ESTATE47.2.1. Debt-Equity Hybrid47.2.2. Holding Value47.3. REAL ESTATE INVESTMENT47.3.1. Investment Characteristics of Each Quadrant47.4. WHY REAL ESTATE?47.4.1. Reduce Aggregate Portfolio Risk47.4.2. Realize a High Absolute Rate of Return47.4.3. Hedge Inflation47.4.4. Reflect the Larger Investment Universe47.4.5. Deliver High Cash Flows47.5. SPECIAL TOPICS IN REAL ESTATE47.5.1. Issue of International Investing47.5.2. Issue of Leverage47.5.3. Emerging Issue of Derivatives47.6. RELATIONSHIPS ACROSS THE QUADRANTS: IS REAL ESTATE REAL ESTATE?47.7. SUMMARY47.8. REFERENCES
48. Investing in Commercial Real Estate for Individual Investors
48.1. IMPORTANCE OF LOCATION48.2. IMPORTANCE OF DIVERSIFICATION48.3. SPECIFIC ADVANTAGES TO INVESTING IN COMMERCIAL REAL ESTATE48.3.1. Financial Leverage48.3.2. Operating Leverage48.3.3. Inflation Resistance48.3.4. Tax Advantages48.3.5. Investing in Real Estate Is Like Owning Your Own Business48.3.6. Debt in an Inflationary World Is Good48.3.7. Compounding Cash Flows48.4. SPECIFIC DISADVANTAGES RELATING TO REAL ESTATE48.4.1. Lack of Liquidity48.4.2. Understanding of Financial Statements48.4.3. Difficulties in Determining Property Value48.4.4. Overextended Borrowing48.4.5. Management Expertise Required48.5. BUSINESS ORGANIZATIONAL FORM48.5.1. Sole Proprietorship48.5.2. General Partnership48.5.3. Limited Partnership48.5.4. Limited Liability Partnership48.5.5. Limited Liability Limited Partnership48.5.6. Registered Limited Liability Partnership48.5.7. Limited Liability Company48.5.8. C Corporation48.5.9. Subchapter S Corporations48.5.10. Closed Corporations48.5.11. Professional Corporations48.5.12. Professional Associations48.5.13. Service Corporations48.5.14. Multiple Forms48.5.15. Franchiser or Franchisee48.6. SUMMARY48.7. REFERENCES
49. Types of Commercial Real Estate
49.1. APARTMENT COMPLEXES49.1.1. Condominiums49.2. TIMESHARES49.3. UNDEVELOPED LAND49.3.1. Raw Land49.3.2. Developing Land49.4. SELF-STORAGE FACILITIES49.5. RESTAURANTS49.6. SHOPPING CENTERS49.6.1. Types of Shopping Centers49.7. RECREATIONAL FACILITIES49.8. OFFICE BUILDINGS49.8.1. Types of Office Buildings49.9. PARKING LOTS49.9.1. Parking Market Segments49.10. HOTELS AND MOTELS49.11. INDUSTRIAL SITES49.12. SUMMARY49.13. REFERENCES
50. Commercial Real Estate Loans and Securities
50.1. LOAN ORIGINATION50.1.1. Underwriting a Loan50.1.2. The Master and Special Servicers50.2. PROPERTY-LEVEL LOANS50.2.1. First-Lien Commercial Mortgage Loans50.2.2. Mezzanine Loans50.2.3. Other CRE Loans50.3. COMMERCIAL MORTGAGE-BACKED SECURITIES50.3.1. Prepayment and Extension Risk50.3.2. Interest Shortfalls50.3.3. Types of CMBS Deals50.4. REIT SECURITIES50.5. EVALUATING CREL AND CMBS50.5.1. Property-Level Analysis50.5.2. Loan-Level Analysis50.5.3. CMBS Bond-Level Analysis50.6. SUMMARY50.7. REFERENCES
51. Commercial Real Estate Derivatives
51.1. USES AND USERS OF COMMERCIAL REAL ESTATE DERIVATIVES51.1.1. Exposure to the Real Estate Asset Class51.1.2. Harvesting Alpha51.1.3. Portfolio Balancing51.1.4. Relative Value Investing51.1.5. Efficient Leverage51.2. EXAMPLE: FORWARD CONTRACT51.3. HARVESTING ALPHA EXAMPLE51.4. CAPITAL RETURN SWAP EXAMPLE51.5. REAL ESTATE INDICES51.6. INCOME AND CAPITAL RETURNS51.7. APPRAISAL-BASED INDICES51.8. TRANSACTIONS-BASED INDICES51.9. SUMMARY51.10. APPENDIX: NUMERICAL EXAMPLE OF HOW THE REPEAT-SALES INDEX WORKS51.11. REFERENCES
5. Alternative Investments
52. Alternative Asset Classes
52.1. SUPER ASSET CLASSES52.1.1. Capital Assets52.1.2. Assets that Can be Used as Economic Inputs52.1.3. Assets that Are a Store of Value52.1.4. Real Estate52.2. ASSET ALLOCATION52.2.1. Asset Classes and Asset Allocation52.2.2. Strategic versus Tactical Allocations52.2.3. Efficient versus Inefficient Asset Classes52.2.4. Constrained versus Unconstrained Investing52.2.5. Asset Location versus Trading Strategy52.2.6. Alternative Beta and the Efficient Frontier52.2.7. Asset Class Risk Premiums versus Trading Strategy Risk Premiums52.3. SUMMARY52.4. REFERENCES
53. Hedge Funds
53.1. HEDGE FUNDS VERSUS MUTUAL FUNDS53.2. CATEGORIES OF HEDGE FUNDS53.3. HEDGE FUND STRATEGIES53.3.1. Market Direction Hedge Funds53.3.2. Corporate Restructuring Hedge Funds53.3.3. Convergence Trading Hedge Funds53.3.4. Opportunistic Hedge Fund Strategies53.4. SHOULD HEDGE FUNDS BE PART OF AN INVESTMENT PROGRAM?53.5. IS HEDGE FUND PERFORMANCE PERSISTENT?53.6. A HEDGE FUND INVESTMENT STRATEGY53.6.1. Opportunistic Hedge Fund Investing53.6.2. Hedge Fund of Funds53.6.3. Absolute Return53.7. SELECTING A HEDGE FUND MANAGER53.7.1. Investment Objective53.7.2. Investment Process53.7.3. What Makes the Hedge Fund Manager so Smart?53.8. SUMMARY53.9. REFERENCES
54. Introduction to Venture Capital
54.1. ROLE OF A VENTURE CAPITALIST54.1.1. Relationship of the Venture Capitalist to Her Investors54.1.2. Restrictions on the Management of the Venture Capital Fund54.1.3. Restrictions on the Activities of the General Partner54.1.4. Restrictions on the Type of Investments54.1.5. Venture Capital Fees54.2. THE BUSINESS PLAN54.2.1. Executive Summary54.2.2. The Market54.2.3. The Product or Service54.2.4. Intellectual Property Rights54.2.5. The Start-up Management Team54.2.6. Operations and Prior Operating History54.2.7. Financial Projections54.2.8. Amount of Financing54.2.9. Exit Plan54.3. CURRENT STRUCTURE OF THE VENTURE CAPITAL INDUSTRY54.3.1. Sources and Uses of Venture Capital Financing54.3.2. Venture Capital Investment Vehicles54.3.3. Life Cycle of a Venture Capital Fund54.3.4. Specialization within the Venture Capital Industry54.4. STAGE OF FINANCING54.4.1. Angel Investing54.4.2. Seed Capital54.4.3. Early-Stage Venture Capital54.4.4. Late-Stage/Expansion Venture Capital54.4.5. Mezzanine Stage54.4.6. J Curve for a Start-up Company54.5. SUMMARY54.6. REFERENCES
55. Assessing Hedge Fund Investment Risk in Common Hedge Fund Strategies
55.1. FIXED INCOME STRATEGIES55.1.1. Government Bond Arbitrage55.1.2. Mortgage-Backed Security Arbitrage55.1.3. Corporate Bond Arbitrage55.1.4. Emerging Markets55.2. EVENT-DRIVEN STRATEGIES55.2.1. Capital Structure Arbitrage55.2.2. Distressed Securities55.2.3. Merger Arbitrage55.3. EQUITY STRATEGIES55.3.1. Long/Short Equity55.3.2. Multistrategy55.3.3. Equity Market Neutral55.3.4. Convertible Arbitrage55.4. SUMMARY55.5. ACKNOWLEDGMENTS55.6. REFERENCES
56. Diversify a Portfolio with Tangible Commodities
56.1. THE BENEFITS OF TANGIBLE COMMODITIES56.1.1. The Historical Returns of Commodities Are Similar to Those of Equities56.1.2. Returns of Commodities Are Not Correlated with Those of Equities and Bonds56.1.3. Add Commodities to Your Portfolio for Increased Risk-Adjusted Return56.1.4. Commodities Can Protect a Portfolio during Periods of Uncertainty56.2. HOW TO GET COMMODITY EXPOSURE56.3. SUMMARY56.4. REFERENCES
57. The Fundamentals of Commodity Investments
57.1. MARKET PARTICIPANTS57.2. COMMODITY SECTORS57.3. COMMODITIES AS AN ASSET CLASS OF THEIR OWN57.3.1. Prospects for Commodity Market Participation57.3.2. Buying the Physical Good57.3.3. Commodity Stocks57.3.4. Commodity Funds57.3.5. Commodity Futures Indices57.3.6. Commodity Futures57.4. COMMODITY EXCHANGES57.5. RISK AND PERFORMANCE CHARACTERISTICS57.6. PORTFOLIO OPTIMIZATION WITH COMMODITIES57.7. SUMMARY57.8. REFERENCES
58. Art Finance
58.1. ART MARKET INDICES58.2. ART AS AN ALTERNATIVE ASSET CLASS58.3. ART FUNDS58.4. SUMMARY58.5. REFERENCES
59. Investing in Life Settlements
59.1. INVESTMENT CHARACTERISTICS59.1.1. Higher Expected IRR/Longer Duration59.1.2. Low Correlation to Other Asset Classes59.1.3. High Credit Quality59.2. VALUATION59.2.1. Variance Estimates59.3. ELEMENTARY LIFE INSURANCE59.3.1. Elementary Life Annuity59.3.2. Forward Values59.3.3. Elementary-Level Premium59.3.4. Substandard Health59.3.5. Elementary Life-Settlement Valuation59.4. PORTFOLIO OF LIFE SETTLEMENTS59.5. SUMMARY59.6. REFERENCES
6. Investment Companies, ETFs, and Life Insurance Products
60. Investment Companies
60.1. TYPES OF INVESTMENT COMPANIES60.1.1. Open-End Funds (Mutual Funds)60.1.2. Closed-End Funds60.1.3. Unit Trusts60.2. FUND SALES CHARGES AND ANNUAL OPERATING EXPENSES60.2.1. Sales Charges or Loads60.2.2. Annual Operating Expenses (Expense Ratio)60.2.3. Multiple Share Classes60.3. ADVANTAGES OF INVESTING IN MUTUAL FUNDS60.4. TYPES OF FUNDS BY INVESTMENT OBJECTIVE60.5. THE CONCEPT OF A FAMILY OF FUNDS60.6. TAXATION OF MUTUAL FUNDS60.7. REGULATION OF FUNDS60.8. STRUCTURE OF A FUND60.9. RECENT CHANGES IN THE MUTUAL FUND INDUSTRY60.9.1. Distribution Channels60.9.2. "Mix and Match" (Open Architecture)60.10. MUTUAL FUNDS VERSUS EXCHANGE-TRADED FUNDS60.11. REFERENCES
61. Exchange-Traded Funds
61.1. THE HISTORY AND STRUCTURE OF ETFs AND SOME COMPETITORS61.1.1. Portfolio Trading61.1.2. Toronto Stock Exchange Index Participations (TIPs)61.1.3. Standard & Poor's Depository Receipts (SPDRs)61.1.4. World Equity Benchmark Shares (WEBS)—Renamed iShares MSCI Series61.1.5. ETFs AND OTHER TRADABLE BASKET PRODUCTS61.1.6. Closed-End Funds61.1.7. "Open" Exchange-Traded Funds61.1.8. Holding Company Depository Receipts (HOLDRs)61.1.9. Folios61.1.10. Exchange-Traded Notes (ETNs) and Other Structured Products61.1.11. A Side-by-Side Comparison of Tradable Basket Products61.1.12. Improving ETFs61.2. SUMMARY61.3. REFERENCES
62. Investment-Oriented Life Insurance
62.1. INSURANCE62.1.1. Conceptual Issues in Risk Management62.1.2. Investment-Oriented Life Insurance Products62.1.3. The Nature of Insurance Companies62.1.4. General Account versus Separate Account Products62.1.5. Overview of Cash Value Whole Life Insurance62.1.6. Taxability of Life Insurance62.2. INVESTMENT-ORIENTED LIFE INSURANCE62.2.1. Cash Value Life Insurance62.2.2. Uses of Life Insurance62.2.3. Annuities62.3. SUMMARY62.4. REFERENCES
63. Stable Value Investment Options for Defined Contribution Plans
63.1. THE NEED FOR STABLE VALUE INVESTING63.1.1. Participant Demand for Safety63.1.2. Plan Design63.1.3. Returns63.1.4. Historical Legacy63.2. TYPES OF STABLE VALUE FUNDING VEHICLES63.2.1. Portfolio Rate General Account63.2.2. GICs63.2.3. Bank Investment Contracts63.2.4. Separate Account Products63.2.5. Synthetic GICs63.2.6. Global Wraps63.2.7. Pooled Funds63.2.8. Individual CD-Type Products63.2.9. Bond Mutual Funds and Other Alternatives63.3. BUYERS OF STABLE VALUE PRODUCTS63.3.1. Book-Value Accounting63.3.2. Types of Buyers63.4. COMMON FEATURES OF STABLE VALUE PRODUCTS63.4.1. Interest Crediting63.4.2. Deposit and Withdrawal Limitations63.4.3. Transfers63.4.4. Withdrawal Hierarchy63.4.5. Need for Exit Provisions63.4.6. Market Value Adjustment63.4.7. Book Value Installments63.4.8. Transfer-in-Kind63.4.9. Annuitization63.5. CONTRACT ISSUANCE63.5.1. Annuity63.5.2. Trust63.5.3. Funding Agreement63.6. PLAN SPONSOR MANAGEMENT ISSUES63.6.1. Diversification and Credit Risk63.6.2. Economy of Purchase63.6.3. Withdrawal Provisions—Participant Benefits63.6.4. Withdrawal Provisions—Plan Sponsor63.6.5. Further Considerations at Time of Transfer63.6.6. The Trade-off among Rate, Liquidity, and Quality63.6.7. Book Value Accounting63.7. ISSUER CONSIDERATIONS63.7.1. Fully Guaranteed Contracts63.7.2. Actively Managed Assets63.7.3. Pooled Funds63.8. ASSET/LIABILITY MANAGEMENT63.8.1. Fully Guaranteed Products63.8.2. Actively Managed Products63.8.3. Pooled Funds63.9. UNDERWRITING63.10. LEGAL AND REGULATORY ISSUES63.11. SOME HISTORICAL LESSONS LEARNED63.11.1. Fully Guaranteed Products63.11.2. Actively Managed Products63.11.3. Pooled Funds63.12. PROS AND CONS OF DIFFERENT STABLE VALUE OPTION FUNDING VEHICLES63.13. NEW DEVELOPMENTS IN PRINCIPAL-PROTECTED PRODUCTS63.14. SUMMARY63.15. REFERENCES
7. Foreign Exchange
64. An Introduction to Spot Foreign Exchange
64.1. BRIEF HISTORY64.2. FOREIGN EXCHANGE EXPOSURE64.3. BASIC USES64.4. CHARACTERISTICS64.5. MAJOR PARTICIPANTS AND THEIR ROLES64.6. SPOT FOREIGN EXCHANGE64.6.1. Spot and Reciprocal Rates64.6.2. European and American Terms64.7. SPOT TRANSACTIONS64.7.1. Bid-Offer Spreads64.7.2. Reading Foreign Exchange Rates64.7.3. Big Figures64.7.4. Spread64.7.5. Direct versus Brokered Dealing64.8. CROSS RATES64.9. PRICE DETERMINANTS64.10. RISK CONSIDERATIONS64.11. ASKING FOR A QUOTE64.12. SUMMARY64.13. REFERENCES
65. An Introduction to Foreign Exchange Derivatives
65.1. FOREIGN EXCHANGE FORWARD CONTRACTS65.1.1. Definitions65.1.2. Interest Rate Differentials65.1.3. Periods65.1.4. Premium or Discount65.1.5. Calculations65.1.6. Bids and Offers65.1.7. To Add or Subtract65.1.8. Forward Quotes65.1.9. Forward Cross Rates65.1.10. Risks Involved65.1.11. Short-Dated Contracts65.1.12. Long-Dated Contracts65.1.13. Broken-Dated Contracts65.1.14. Outright Forwards65.2. NONDELIVERABLE FORWARDS65.2.1. Fixing Methodology65.2.2. How Quoted65.2.3. Risk Management Tool65.2.4. Availability65.2.5. Typical Risks Encountered65.2.6. Index-Linked Deposits65.2.7. Summary of Characteristics65.3. FOREIGN EXCHANGE SWAPS65.3.1. Combinations65.3.2. Uses65.3.3. Formula65.3.4. Uses of Swaps65.3.5. Risks65.4. CURRENCY SWAPS65.4.1. Technique Involved65.4.2. No Interest Payable65.4.3. Flexibility65.4.4. Liquid and Cost Effective65.4.5. Exposure65.4.6. Graphic Example65.5. FOREIGN EXCHANGE FUTURES65.5.1. Two-Sided Risk65.5.2. Margin65.5.3. Exchange Members65.5.4. Clearing Corporation65.5.5. Major Exchanges65.5.6. Quoting Currency Futures65.5.7. Ticks and Delivery Months65.5.8. Contract Specifications65.6. EXCHANGE FOR PHYSICAL65.6.1. Example 165.6.2. Example 265.6.3. Point of the Exercise65.6.4. Interbank versus Futures65.7. SUMMARY65.8. REFERENCES
66. Introduction to Foreign Exchange Options
66.1. FOREIGN EXCHANGE OPTIONS66.1.1. Call Option66.1.2. Put Option66.1.3. Exchange-Traded Options versus Over-the-Counter Options66.1.4. Applications of Foreign Exchange Options66.1.5. Alternatives to Foreign Exchange Options66.1.6. Parties and the Risks Involved66.1.7. Currency or Dollar Call or Put Option?66.1.8. Users of Foreign Exchange Options66.1.9. Differences between Hedging and Speculation66.1.10. American versus European66.2. BASICS OF OPTION THEORY66.2.1. In-, At-, or Out-of-the-Money66.3. THE PREMIUM66.4. OTHER CONSIDERATIONS66.4.1. Pricing Theory66.4.2. Market Conventions66.4.3. Strike Price and Strike Selection66.4.4. Live Price66.4.5. Premium Conversions66.4.6. Settlement and Exercise66.4.7. Risks66.5. SUMMARY66.6. REFERENCES
8. Inflation-Hedging Products
67. Inflation-Linked Bonds
67.1. INFLATION, INVESTING, AND CONSUMPTION67.2. INFLATION BOND BASICS: THEORY AND STRUCTURE67.3. WHY INFLATION-LINKED BONDS?67.3.1. Gauging Inflation Expectations and Preventing Policy Errors67.3.2. Managing Inflation and Inflation Expectations67.3.3. Liability Management67.3.4. Risk Diversification67.3.5. Active Management67.4. BEHAVIOR OF INFLATION-LINKED BONDS67.4.1. Return Decomposition67.4.2. Saving the Inflation Risk Premium?67.4.3. Low Volatility67.4.4. Correlation67.4.5. Triple Duration67.4.6. Taxes67.4.7. Asset Allocation and Portfolio Construction67.4.8. Spending Policy67.5. CONTINUING ISSUES67.5.1. Why so Little Nonsovereign Issuance?67.5.2. What Is the Future of the Inflation-Linked Bond Market?67.6. SUMMARY67.7. REFERENCES
68. Introduction to Inflation Derivatives
68.1. INFLATION DERIVATIVES MARKET68.2. INFLATION BASICS68.2.1. Inflation, Nominal Value, and Real Value68.2.2. Real Bonds and Inflation-Linked Cash Flows: Ideal World68.2.3. Real Bonds and Inflation-Linked Cash Flows: Practice68.2.4. Breakeven Inflation68.3. INFLATION PRODUCTS68.3.1. Zero-Coupon Inflation Swap68.3.2. Period-on-Period Inflation Swaps68.3.3. Inflation Futures68.4. ISDA INFLATION DERIVATIVES DOCUMENTATION68.4.1. Delay of Publication68.4.2. Successor Index68.4.3. Cessation of Publication68.4.4. Rebasing the Index68.4.5. Material Modification Prior to Payment Date68.4.6. Manifest Error in Publication68.5. SUMMARY68.6. REFERENCES
9. Inflation-Hedging Products
69. An Introduction to Securities Lending
69.1. WHAT IS SECURITIES LENDING?69.1.1. Different Types of Securities Loan Transaction69.1.2. Other Transaction Types69.2. LENDERS AND INTERMEDIARIES69.2.1. Intermediaries69.2.2. Principal Intermediaries69.2.3. Beneficial Owners69.3. THE BORROWING MOTIVATION69.3.1. Borrowing to Cover Short Positions69.4. MARKET MECHANICS69.4.1. Loan Negotiation69.4.2. Confirmations69.4.3. Term of Loan, and Selling Securities While on Loan69.4.4. Term Trades—Fixed or Indicative?69.4.5. Putting Securities "On Hold"69.4.6. Settlements69.4.7. Termination of the Loan69.4.8. Redelivery, Failed Trades, and Legal Remedies69.5. FINANCIAL RISKS AND RISK MANAGEMENT69.5.1. When Taking Cash as Collateral69.5.2. When Taking Other Securities as Collateral69.6. SUMMARY69.7. ACKNOWLEDGMENTS69.8. REFERENCES
70. Mechanics of the Equity Lending Market
70.1. THE LENDING PROCESS70.2. LENDERS70.2.1. Lender's Rights70.2.2. Lender's Risks70.3. BORROWERS70.4. THE DETERMINANTS OF REBATE RATES70.5. SUMMARY70.6. REFERENCES
71. Securities Lending, Liquidity, and Capital Market-Based Finance
71.1. The great_transition_the_rise_of_CAPITAL_MARKET-BASED_FINANCE71.2. FINANCIAL COMPLEXITY AND INTENSIFICATION71.3. THE CENTRAL ROLE OF LIQUIDITY71.3.1. Evolution of the U.S. Securities Lending Market71.3.2. Securities Lending: Key to Market Liquidity71.3.3. How Securities Lending Finances Liquidity71.3.4. Recognizing Securities Lending's Key Roles71.3.5. Repo and Securities Lending71.4. THE EMERGING OFFICIAL CONSENSUS: FOSTERING CAPITAL MARKETS AND SECURITIES LENDING71.5. SUMMARY71.6. REFERENCES
72. Repurchase Agreements and Dollar Rolls
72.1. REPURCHASE AGREEMENTS72.1.1. The Basics72.1.2. Credit Risks72.1.3. Determinants of the Repo Rate72.1.4. Special Collateral and Arbitrage72.1.5. Participants in the Market72.1.6. Repo/Reverse to Maturity72.1.7. Buy/Sell-Back72.1.8. Repo Market Structures72.1.9. LIBOR Financed Treasury Repo72.2. DOLLAR ROLLS72.2.1. Background Information on Agency Pass-throughs72.2.2. Determination of the Financing Cost72.2.3. Illustrations of Dollar Roll Agreements72.2.4. Risks in a Dollar Roll from the Investor's Perspective72.3. SUMMARY72.4. REFERENCES

Content preview from Handbook of Finance: Financial Markets and Instruments

Chapter 34. Commercial Mortgage-Backed Securities

JAMES MANZI, CFA

Consultant

DIANA BEREZINA

Associate Director, Fitch Ratings

MARK ADELSON

Principal, Adelson & Jacob Consulting, LLC

Abstract: Commercial mortgage-backed securities (CMBSs) are a type of fixed income investment backed by commercial loans. They can be appealing to investors because they generally offer high credit quality, a reasonable degree of credit stability, cash-flow stability, and low-spread volatility. Choosing a particular CMBS investment involves careful consideration of the characteristics of the underlying commercial loans, bond structure, risk appetite, and typical deal features.

Keywords: commercial mortgage-backed securities (CMBSs), commercial loans, CMBS bond structure, CMBS deal features, prepayment penalties, defeasance, yield maintenance

This chapter is intended to provide an overview of the commercial-mortgage backed securities (CMBSs) market and the tools to choose between different CMBS investments based on relative value considerations, risk characteristics, and nuances in bond structure.

INVESTMENT CHARACTERISTICS OF TRADITIONAL (CASH) CMBS

CMBSs are backed by commercial mortgage loans. That is, the underlying mortgage loans are secured by commercial, rather than residential, real estate. In contrast to residential mortgage loans, most commercial mortgage loans in the United States do not allow for unrestricted prepayments by the borrowers. Accordingly, a key distinction between CMBS and residential ...

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Chapter 34. Commercial Mortgage-Backed Securities

INVESTMENT CHARACTERISTICS OF TRADITIONAL (CASH) CMBS

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