This chapter introduces fixed income portfolio management in practice. We begin by describing the different sectors of the bond market. We then review fundamental fixed income terminology, including features of fixed income securities (term to maturity, maturity, coupon rate, par value, yield, provisions for paying off bonds, and bondholder option provisions) as well as major sources of risk for a bond investor. Important fixed income analytics concepts for measuring bond portfolio risk, including duration, convexity, key rate duration, and spread duration, are discussed next. We conclude with an overview of the spectrum of bond portfolio strategies. The next chapter shows explicit examples of how these concepts are used in the context of fixed income portfolio construction and risk decomposition with factor models.
13.1 Fixed Income Instruments and Major Sectors of the Bond Market
A fixed income security is a financial instrument whereby an entity agrees to make specified payments to the holder of the security. The key feature is that the entity issuing the security (i.e., the issuer) will be making contractually specified payments according to a schedule. Bear in mind that the payments need not be fixed in dollar amounts. The amounts can vary over time but what is important is that the holder of the security cannot receive more than the scheduled amount.
Fixed income securities are classified as either a debt instrument ...