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Christophe Dispas

Fundamentals

What is a bond?

Financial obligation

Time Value of

Money

Stream of future cash flows :

Interest payments

Principal repayment

Principal : legal structure different from its coupons

Fixed Income

Portfolio Bond indenture

Management

Strategies

Any assets a prior claim of creditors?

Garantees and commitments?

Fundamentals

Coupon and principal

Fundamentals

Face value :

Total amount repaid at maturity

Used to determine coupon payments

Time Value of

Money Time to maturity

Maturity date

Portfolio

Management

Annually, semi-annually, …

Strategies

Legal differences : expected return pre tax and after

tax

Fundamentals

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Fundamentals

Price quotes

US : in 32nds of a percent

Time Value of Size of minimum price change

Money

Fixed Income

Portfolio

Management

Strategies

Fundamentals

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Fundamentals

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Fundamentals

Accrued interest

Fundamentals

Clean price = net of interest

Time Value of

Money

clean price

Portfolio

Management

Principal x (Coupon rate/Nr. Coupons per year) x fractional coupon period

Strategies

Fundamentals

Accrued interest : use the right conventions

Coupon Frequency Accrued Interest

Government Bonds

Fundamentals USA Semi-annual Actual/Actual

UK Semi-annual Actual/Actual

Time Value of

Netherlands Annual Actual/Actual

Money

Canada Semi-annual Actual/365

Corporate Bonds

Fixed Income USA Annual or Semi-annual 30/360

Portfolio

Management UK Semi-annual Actual/365 or

Actual/Actual *

Strategies

Eurobonds

Issued Annual 30/360

before 1/1/99 (some Semi-annual)

Issued Annual Actual/Actual

after 31/12/99 (some Semi-annual)

Fundamentals

Types of fixed income securities

Straight bond

Interest payments periodically

Fundamentals

Principal at maturity

Sinking-fund provision

Time Value of

Sinker percentage : retire a portion of the

Money outstanding debt (sinker percentage), each year

Callable bonds

Issuer has the right to repurchase the bond at

Fixed Income call price, at call date

Portfolio

Management

Protect issuer if interest rate drop

Strategies

Fundamentals

Types of fixed income securities

Fundamentals

Bullet bonds : bonds that cannot be redeemed prior to

maturity

Time Value of

Perpetual bonds : principal never redeemed

Money

Zero-coupon bonds :

Do not pay any interest

Generally issued at large discount to the face value

Fixed Income

Portfolio

Management

Stripped bonds :

Strategies Zero-coupon bonds

Artificially created from default risk free

government bonds

Fundamentals

Types of fixed income securities

Income bonds :

Pays interest only if profits of the issuing firm are

Fundamentals

adequate enough to pay interest

A missed coupon is not a default

Cumulative / non-cumulative

Time Value of

Money Floating rate notes :

Coupon adjusted periodically

Depend on a base or benchmark rate

Portfolio

Management

Interest paid in one currency, principal in another

Strategies Foreign interest payment securities

Multiple currency clause bonds

Fundamentals

Convertible bond :

Fundamentals The holder can exchange the security for shares of

the company

Terms set in the bond indenture (number of

shares, …)

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Fundamentals

4 types of bonds based on the issuer :

Domestic bonds :

Domestic issuer

Fundamentals

Usually in local currency

Foreign bonds :

Time Value of

Foreign issuer

Money Local market

Usually local currency

Eurobonds :

Fixed Income Multinational syndicate

Portfolio

Management

All countries other than the one in whose currency

Strategies the bond is denominated

Trade in the international marketplace

Global Bonds

Fixed Income : Valuation and Analysis- 14

Fundamentals

Maturities up to 12 months

Money

Portfolio

Management

Strategies

Fundamentals

Money

high enough (relative to other participants’ bid)

Fixed Income

Portfolio Non-competitive auction : price is equal for all the

Management

Strategies

subscribers (marginal price or average price)

Fundamentals

Commercial paper

Fundamentals

Time Value of

Money

Usually guaranteed by a bank line of credit

Rating

Fixed Income

Portfolio Most frequent maturities : 1 or 2 months

Management

Strategies

Source of funds cheaper than the ordinary bank

borrowing

Fundamentals

Bankers’ acceptance

Fundamentals

has been guaranteed by a bank

Time Value of

Money Traded at a discount

Portfolio

Management

Strategies Usually less risky than commercial paper

Fundamentals

Fundamentals

Time Value of

Money

Usually a fixed rate of interest, paid at maturity

Fixed Income secondary market

Portfolio

Management

Strategies

Fundamentals

Government bonds :

Fundamentals

US Government bonds :

Time Value of

Money Treasury bonds : 10 to 30 years

Semi-annual coupon payments

Government guaranteed : low credit risk

Circulation is managed by Central Bank book-entry

Fixed Income form : no physical circulation

Portfolio

Management

Strategies

Fundamentals

Corporate securities

Fundamentals

Time Value of

Money

Up to 10 years : notes; Over 10 years : bonds

Fixed Income traditional classification is sectorial

Portfolio

Management

Strategies

Fundamentals

Corporate securities

Fundamentals

Credit quality :

Offer document

Ratings

Time Value of

Money Protection :

Mortgage bonds

Collateral trust bonds

Senior claim

Fixed Income

Portfolio

Management

Strategies

Fundamentals

Corporate securities

creditors’ one (the claim is junior)

Fundamentals

Subordinated debenture bonds :

Rank after secured bonds in claim on corporate

earnings and assets

Time Value of

Money Difference in protection = difference in yield

Portfolio

Management

Strategies Sinking funds :

Control the credit risk

Balloon payment : amount remaining

Accelerated sinking fund

Fixed Income : Valuation and Analysis- 23

Fundamentals

Indices

Fundamentals

Time Value of

Money rebalancing services to investors

Portfolio

Management

Strategies

Fundamentals

Indices

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Fundamentals

Indices

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Fundamentals

Indices

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

requires incentive : interest rate

Fundamentals

Simple vs compound interest

Hypothesis : interest payments are not reinvested

Time Value of

Money

Compound interest

Interest is reinvested

Fixed Income Compound interest =

Portfolio

Management

Strategies (initial amount) . [(1+ interest rate)nbrofyears - 1]

Time value of money

Simple interest

Fundamentals

Time Value of

Money

Compound interest

Fixed Income

Portfolio

Management

Strategies

Time value of money

Simple interest

Fundamentals

Time Value of

1000 EUR . 0,07 . 10 = 700 EUR

Money

Compound interest

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Time Value of

Money Example :

Fixed Income

annual interest rate

Portfolio

Management End year 1 : 100 000 EUR . (1+ 0,05) = 105 000 EUR

Strategies

End year 2 : 105 000 EUR . (1 + 0,05) = 110 250 EUR

Fixed Income : Valuation and Analysis- 33

Time value of money

Fundamentals

greater accumulation of compound interest

Example

Time Value of

Money

1000 EUR, interest rate = 10,5%, 67 years

Fixed Income Simple interest : 1000 EUR + (1000 EUR . 0,105 . 67) = 8 035 EUR

Portfolio

Management

Strategies

Compound interest : 1000 EUR . (1+0,105)67 = 804 030,69 EUR

Time value of money

Annuities

years

Fundamentals

Hypothesis :

Time Value of

First payment is received one year from now

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Annuities

Present value

Fundamentals

Time Value of

Money

Future value

Fixed Income

Portfolio

Management

Strategies

Time value of money

Annuities

Future value

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Time Value of

Money

When m tends to infinity :

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Current yield

Fundamentals

Time Value of

Money

Bond’s current yield varies inversely with the

Fixed Income bond’s price

Portfolio

Management

Strategies

Time value of money

Bond yield measures

Current yield

Fundamentals

Not adequate to compare bonds

Time Value of Current yield of a bond under par decrease as

Money the bond approaches maturity

Fixed Income

Portfolio

Management

Strategies

Time value of money

Yield to maturity

Fundamentals

Discount rate that equals present value of future

cash flows and market price :

Time Value of

Money

Fixed Income

Internal rate of return (IRR) of the investment in the

Portfolio bond

Management

Strategies

Time value of money

Yield to maturity

Fundamentals

Time Value of

Money

Portfolio

Management

Cash flows are received as scheduled

Strategies YTM is not the total return of a bond

Time value of money

Yield to maturity

Fundamentals

Time Value of

Money

On a Euromarket :

Fixed Income

Portfolio

Management

Strategies

On the US or English market :

Time value of money

Yield to maturity

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Yield to maturity

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies With annual coupon : 4.72%

Time value of money

Fundamentals

Accrued interest

Total price = Market price + f . Coupon

Usually, f = (nbr of days between last coupon and

Time Value of

Money today / nbr total of days between the two coupons)

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Adjusted formula :

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Yield to maturity

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies NB :

With a financial calculator, the clean price is used

to compute

Time value of money

Yield to maturity

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Yield to maturity

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

=> Calculate bond prices

Strategies

Time value of money

Yield to maturity

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies => With these prices, calculate YTM

Time value of money

Yield to maturity

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies => YTM is an average of the spot rates

Time value of money

Yield to maturity

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

⇒YTM is an average of the spot rates

Time value of money

Yield to maturity

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

⇒ If R0,t are increasing, YTM will underestimate the

corresponding spot rate R0,T

Fixed Income : Valuation and Analysis- 56

Time value of money

Yield to maturity

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

⇒ Bias increase for larger coupon rates

Time value of money

Yield to maturity

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Yield to call

Fundamentals

Time Value of

Money

Assumes that the bond will be called

Assumes that all cash flows are received as scheduled

through the call date

Fixed Income

Portfolio

Management

Strategies

Time value of money

Yield to call

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Yield to call

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies Yield to call differs from yield to maturity

Discounting period is shorter

Final cash flow is generally higher

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Bond yield measures

average life date

Useful to compare bonds with a series of principal

repayment with bullet bonds

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Call-adjusted yield

Fundamentals

bonds

Time Value of

Money Price of the non callable bond = price of the

callable bond + value of the call option

Fixed Income = call date

Portfolio

Management

Strategies YTM callable bond = YTM bullet bond with price

adjusted for the price of the call

Time value of money

Bond yield measures

Call-adjusted yield

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Lending date : money is to be loaned

Time Value of Repayment date : money is to be repaid

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

coupon bond maturing at t

Time Value of

Money

ONE final payment for interest and principal

Fixed Income

Portfolio Generally, spot rates are quoted as annual rates

Management

Strategies

Time value of money

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

date (0) different from lending date (t)

Time Value of

Money

Pay only one cash flow

Fixed Income

Portfolio

Management

Strategies

Time value of money

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Relationship between the yields on comparable bonds

with different maturities

Money

is essential in bond management

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Time Value of

Money

Few corporates zero-coupon bonds

Portfolio

Management

Strategies

Time value of money

Yield curve

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Definitions

Fundamentals

Term structure : relationship between spot rates and

time to maturity

Money time to maturity

Fixed Income

Portfolio better

Management

Strategies

Time value of money

Definitions

risk premium

Time Value of

Money

consumption

power over time

Fixed Income

Portfolio Risk premium : protects investors against all other

Management

Strategies potential negatives

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Credit risk

Time Value of

Call risk

Money

Coupon rate

Portfolio

Management

Strategies

Time value of money

Term structure of interest rates : shapes

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Term structure of interest rates : shapes

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Fixed Income : Valuation and Analysis- 97

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Time value of money

Expectations hypothesis

Fundamentals

Liquidity preference

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

100

Time value of money

Theories of term structures

Expectations hypothesis

Fundamentals

Reflects market consensus forecast on future

interest rates levels

Money future spot rate :

Fixed Income

Portfolio

Management

Strategies

101

Time value of money

Theories of term structures

Expectations hypothesis

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

102

Time value of money

Theories of term structures

Expectations hypothesis

Fundamentals

should adjust

future spot rate :

Time Value of

Money ⇒ Without transaction costs, each bond is a

perfect substitute for any other bond, whatever its

maturity

Fixed Income

Portfolio In this case, these 3 strategies are equivalent :

Management

Strategies

Buy and hold strategy

Rollover strategy

Buy a bond and sell it prior to maturity

Fixed Income : Valuation and Analysis-

103

Time value of money

Theories of term structures

Expectations hypothesis

Fundamentals

Explains the slope of the curve : slope = expectation

of rates

Money

Homogenous expectations

Investors choose between short and long-term

bonds in order to maximise their final expected

Fixed Income

Portfolio

wealth for a given investment period

Management No transaction costs

Strategies Bond markets are efficients

104

Time value of money

Expectations theories

Fundamentals

Naive expectations hypothesis :

Expected returns for any strategy for any

holding period are equal

Time Value of

Money

Local expectations :

Refers only to total returns over a (short) period

beginning at the present

Fixed Income

Portfolio Unbiased expectations :

Management

Forward rates equals future EXPECTED spot

Strategies

rates

105

Time value of money

Expectations theories

Fundamentals

Expected return of holding a bond up to maturity

has to be equal to the expected return we would

Time Value of

Money obtain by rolling over a sequence of single-period

bonds over the same horizon

Fixed Income This version deals with periodic returns, while

Portfolio

Management

return to maturity version is concerned with total

Strategies returns over the investment horizon

106

Time value of money

Theories of term structures

Expectations theories

Fundamentals

with an equilibrium (arbitrage profits for the

Time Value of

others)

Money The remaining four versions are not equivalent

or consistant with each other with UNCERTAIN

interest rates

Portfolio

Management hypothesis

Strategies

Relation derived for a one year period is

inconsistant with relation derived for a two year

period under the naive expectations hypothesis

Fixed Income : Valuation and Analysis-

107

Time value of money

Theories of term structures

Liquidity preferences

Fundamentals

In expectation theory, investors don’t have maturity

preference

Money liquid securities

loss

Fixed Income

Portfolio

Management Fluctuation risk is higher for long term bonds

Strategies investors prefer short term securities

108

Time value of money

Theories of term structures

Liquidity preferences

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

109

Time value of money

Liquidity preferences

Fundamentals

Borrowers prefer to issue long to avoid interest

rates fluctuations

Money

Two factors in the observed term structure of interest

rates :

Future expected short term spot rates

Fixed Income

Portfolio A positive liquidity premium

Management

Strategies

110

Time value of money

Theories of term structures

Liquidity preferences

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

111

Time value of money

Theories of term structures

Liquidity preferences

Fundamentals

Time Value of

Money

Expected return on buy and hold strategy has to be

higher than the expected return on a rollover strategy

Portfolio

Management

Strategies

Term structure of interest rate should be mainly upward

sloping

112

Time value of money

Fundamentals

Bond markets : distinct markets that differ by their

maturity

Money

and sufficiently risk-averse to operate ONLY in this

spectrum

Portfolio maturity range

Management

Strategies

113

Time value of money

Theories of term structures

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

114

Time value of money

Fundamentals

Risk premium can be positive, negative or zero

Time Value of

Money

Fixed Income

Portfolio Term structure of interest rates : supply and

Management

Strategies demand of each individual segments

changes in the term structure of interest rates

Fixed Income : Valuation and Analysis-

115

Time value of money

Fundamentals

Time Value of

Money

Negatively sloped : preference for the long term

Fixed Income

Portfolio Humped : different preferences for different

Management

Strategies maturities

116

Time value of money

Fundamentals

Limits :

Time Value of

segment for a sufficiently higher yield

Money

premium is high enough to cover risks and costs

Fixed Income leaving it

Portfolio

Management

Strategies

117

Time value of money

stochastic factors

Time Value of

Money Factors evolves over time according to a particular

hypothesized stochastic process

No arbitrage opportunity

Fixed Income

Portfolio

Management

Strategies

118

Time value of money

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

119

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

120

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

121

Time value of money

Fundamentals

Yield spread : differential in the yields of two or more

bonds

Time Value of

Money those spreads

security having comparable maturity

Fixed Income Highest quality in marketability, credit risk and,

Portfolio

Management

often, tax status

Strategies

Spread = risk premium

Fixed Income : Valuation and Analysis-

122

Time value of money

Bond price analysis

Time Value of

Money

Yield ratio

Fixed Income

Portfolio

Management

Strategies

123

Time value of money

Bond price analysis

Credit quality (Rating)

Time Value of Maturity

Money

Coupon

Fixed Income

Portfolio Maturity

Management

Strategies

Credit

Embedded options

Tax status

Liquidity

Fixed Income : Valuation and Analysis-

124

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

125

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

126

Time value of money

Fundamentals

Determinants of yield spreads :

Credit

Time Value of

Money Probability of default

Fixed Income

Portfolio

Management

Strategies

127

Time value of money

Bond price analysis

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

128

Time value of money

Bond price analysis

recession

Time Value of

Money

Higher probability of default in recession

Fixed Income

Portfolio Formula (p=probability of total payment)

Management

Strategies

129

Time value of money

Bond price analysis

Fundamentals

Credit spread :

Money

Fixed Income

Portfolio

Management

Strategies

130

Time value of money

Fundamentals

Embedded options

Time Value of

exercise it => yield differential

Money

Fixed Income

Portfolio

Management

Strategies

131

Time value of money

Fundamentals

Tax status

Time Value of

Money Taxable bond has to pay higher yield to

compete with an exempt bond

Fixed Income

Portfolio

Management

Strategies

132

Time value of money

Fundamentals

Tax status

Money

Fixed Income

Portfolio

Management

Strategies

133

Time value of money

Fundamentals

Liquidity

Time Value of the required yield

Money

Marketability : broad and deep market

Fixed Income

Portfolio

Management Financiability : the issue can be liquid, but is

Strategies

utilized as a collateral to borrow funds

134

Time value of money

Bond price analysis

Bond valuation

Fundamentals

Discounted cash flow method

Equilibrium concept

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies Example : ZC bond, pay 1000 EUR in 5 years,

discount rate = 7%; 7 year bond ?

135

Time value of money

Bond price analysis

Bond valuation

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

136

Time value of money

Bond valuation

Fundamentals

Generally, discount rate varies from maturity to

maturity

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

137

Time value of money

Bond price analysis

Bond valuation

Static arbitrage and valuation of coupon bonds

Fundamentals

A coupon-bearing bond can be visualised as a

portfolio of zero-coupon bonds

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

138

Time value of money

Bond price analysis

Bond valuation

portfolio of zero-coupon bonds

Time Value of

Money Bond price = price of replicating ZC bond

portfolio

Fixed Income

Portfolio

Management

Strategies

final cash flow is modified

Fixed Income : Valuation and Analysis-

139

Time value of money

Bond valuation

Fundamentals

Static arbitrage and valuation of coupon bonds

Time Value of

Money CFt = cash flow received at the end of the

SEMI-ANNUAL period (ex : 2% on a 4%

coupon)

Fixed Income

Portfolio R = required rate of the SEMI-ANNUAL

Management period

Strategies

T : nbr of years x 2

140

Time value of money

Bond price analysis

Bond valuation

Fundamentals

Static arbitrage and valuation of coupon bonds

Time Value of

Money New coupon = market spot rate for the

next period

Fixed Income

Portfolio

be at par

Management

Strategies Short term zero coupon with maturity =

next coupon payment (sell the bond at 100)

141

Time value of money

Bond price analysis

Bond valuation

Fundamentals

Static arbitrage and valuation of coupon bonds

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

142

Time value of money

Bond price analysis

Bond valuation

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

143

Time value of money

Bond price analysis

Bond valuation

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

144

Time value of money

Bond price analysis

Bond valuation

Fundamentals

Static arbitrage and valuation of coupon bonds

Time Value of

Money Coupon rate not always equal to the market

spot rate for the next period

Default risk

Fixed Income

Portfolio Announcement of the next coupon rate not

Management

Strategies always on the previous-coupon payment date

145

Time value of money

Bond price analysis

Bond valuation

Money

lower coupon issue with the same maturity

Fixed Income

Portfolio

Management

Strategies

146

Time value of money

Bond price analysis

Bond valuation

discount rate of interest

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

147

Time value of money

Bond price analysis

Bond valuation

Strips markets

Fundamentals

Principal

Time Value of

Money Zero coupon notes

Portfolio

Management

One 10 year zero coupon

Strategies

Created by financial institutions

Fixed Income : Valuation and Analysis-

148

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

149

Time value of money

Bond price analysis

Yield to maturity :

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

150

Time value of money

Bond price analysis

Fundamentals

Yield to maturity : proxy for total return if

market rate)

Time Value of

Money

Reinvestment rate risk : long term bonds, high

coupon rate

Portfolio

Management

Strategies YTM must be expressed in annual equivalent

supported by theory

Fixed Income : Valuation and Analysis-

151

Time value of money

Bond price analysis

Fundamentals

Yield to maturity vs total return :

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

152

Time value of money

PRICING

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

153

Time value of money

PRICING

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

154

Time value of money

TERM STRUCTURE OF INTEREST RATES

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

155

Time value of money

TERM STRUCTURE OF INTEREST RATES

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

156

Time value of money

Risk measurement

Fundamentals

Risk of a bond : impact of market factors on return

characteristics

Money interest rate fluctuation

Fixed Income Price risk : sell a bond prior to the maturity date

Portfolio

Management

Strategies Reinvestment risk

Fixed Income : Valuation and Analysis-

157

Time value of money

Risk measurement

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

158

Time value of money

Risk measurement

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

159

Time value of money

Risk measurement

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

160

Time value of money

Risk measurement

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

161

Time value of money

Risk measurement

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

162

Time value of money

Risk measurement

Fundamentals

Bond with sinking fund provision less volatile

Time Value of

Money Price volatility is not a symmetric phenomenon

Fixed Income

Portfolio

Management

Strategies

163

Time value of money

Risk measurement

Fundamentals

Time to maturity

Time Value of

Money

Long maturity bonds riskier

Fixed Income More sensitive to interest rate fluctuations

Portfolio

Management

Strategies

164

Time value of money

Risk measurement

Cash flows prior to final maturity

Time Value of Linear relationship between time to maturity

Money

and price volatility

Fixed Income

Portfolio

Management

Strategies

165

Time value of money

Risk measurement

Time Value of

Money

Fixed Income

Portfolio Identical to time to maturity for bullet bonds

Management

Strategies

Better for Sinking requirement and MBS

Fixed Income : Valuation and Analysis-

166

Time value of money

Risk measurement

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

167

Time value of money

Risk measurement

Money

Fixed Income

Portfolio

Management

Strategies

168

Time value of money

Risk measurement

years

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

169

Time value of money

Risk measurement

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

170

Time value of money

Risk measurement

Duration of a ZC = maturity

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

171

Time value of money

Risk measurement

Fundamentals

Duration and modified duration

Time Value of requirements : same methodology

Money

Fixed Income

Portfolio

Management

Strategies

172

Time value of money

Risk measurement

Fundamentals

Interpretations

Time Value of

Money Cash flows

YTM

P

Portfolio

Management

duration date of the coupon bearing issue

Strategies

173

Time value of money

Risk measurement

Fundamentals Interpretations

bond is not sensitive to interest rate variation

Time Value of

Money

If you sell at the time of its duration, holding

period return = current market yield

Fixed Income

Portfolio

Management

Strategies

174

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

175

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

176

Time value of money

Risk measurement

Money

Fixed Income

Portfolio

Management

Strategies

177

Time value of money

Risk measurement

Fundamentals

Determinants of duration

Time to maturity

Coupon

Time Value of

Money Accrued interest

Market yield

Sinking fund

Call features

Fixed Income

Portfolio

Management

Strategies

178

Time value of money

Risk measurement

Money

Fixed Income

Portfolio

Management

Strategies

179

Time value of money

Risk measurement

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

180

Time value of money

Risk measurement

Fundamentals

Determinants of duration

interest

Time Value of

Money

Higher coupon lead to a decline in

duration, but at a diminishing rate

Fixed Income

Portfolio

Management

Strategies

181

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

182

Time value of money

Risk measurement

Fundamentals

Determinants of duration

Time Value of interest

Money

D increases on coupon payment date

Fixed Income

Portfolio

Management

Strategies

183

Time value of money

Risk measurement

Fundamentals

Determinants of duration

interest rates (yield level)

Time Value of

Money

Higher discount rate = lower duration

Fixed Income

Portfolio

Management

Strategies

184

Time value of money

Risk measurement

Money

Price duration

Fixed Income

Portfolio

Management

Strategies

change in the yield

Fixed Income : Valuation and Analysis-

185

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

186

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

187

Time value of money

Risk measurement

Initial market yield : 6%; Duration : 7,8 years

Convexity

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

188

Time value of money

Risk measurement

Convexity

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

189

Time value of money

Risk measurement

Convexity

with a straight line

Time Value of

Money

Will not exhibit the asymmetry in price volatility

Fixed Income

Portfolio Accuracy depends on the convexity

Management

Strategies

Duration : not for large variation in yield

Fixed Income : Valuation and Analysis-

190

Time value of money

Risk measurement

Convexity

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

191

Time value of money

Risk measurement

Convexity

on price

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Convexity = Rate of change of the slope of the

price-yield curve with respect to yield changes

192

Time value of money

Risk measurement

Convexity

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

193

Time value of money

Risk measurement

Convexity

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

194

Time value of money

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

195

Time value of money

Risk measurement

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

196

Time value of money

Risk measurement

Fundamentals

Duration will suddenly increase at the coupon

payment

Time Value of

Money

Fixed Income Duration will decrease linearly with time between two

Portfolio

Management coupon payments

Strategies

All other things being equal, duration of a portfolio

will vary linearly over time, except when there is a

coupon payment

Fixed Income : Valuation and Analysis-

197

Time value of money

Risk measurement

assumptions :

Time Value of

Money

A parallel shift in the yield, whatever the maturity

Fixed Income

Portfolio

Management

Strategies

⇒ Assumes a flat yield curve

particuliar rate change

Fixed Income : Valuation and Analysis-

198

Time value of money

Risk measurement

average of the durations of the individual bonds

Time Value of

Money

Fixed Income average of the convexities of the individual bonds

Portfolio

Management

Strategies

199

Time value of money

Credit risk

Fundamentals payment of interest and/or principal

Money

Economic and financial current and prospective

conditions

Fixed Income Economic / Industry / Firm specific considerations

Portfolio

Management

Strategies

200

Time value of money

Credit risk

Growth prospects

Money

Competition

Portfolio

Management

Strategies

Degree of regulation

Labor

201

Time value of money

Credit risk

Ratio analysis

Fundamentals

Cash flow from operations (long term)

Time Value of

Money Another source of financing

Fixed Income

accounts

Portfolio

Management

Strategies

202

Time value of money

Credit risk

Ratio analysis

Fundamentals

Common size ratios

Profitability ratios

Time Value of

Money Liquidity ratios

Solvency ratios

Portfolio

Management

Strategies

203

Time value of money

Credit risk

Fundamentals

EX : Moody’s, Standard & Poor’s

Time Value of

Money Fundamentals of the company

Industry data

Portfolio

Management

Strategies => Probability of the default in interest and/or

principal payments

204

Time value of money

Credit risk

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

205

Time value of money

Credit risk

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

206

Time value of money

Credit risk

Money

towards bankrupcy

Fixed Income

Portfolio Bond ratings have a direct effect on the borrowing

Management

Strategies costs of the issuer

207

Time value of money

EVALUATION AND RISK

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

208

Time value of money

EVALUATION AND RISK

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

209

Time value of money

EVALUATION AND RISK

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

210

Fixed Income Portfolio Management

Strategies

Active Management : to beat the benchmark

Forecasting returns

Fundamentals

Parallel shifts of the yield curve

Time Value of

Money Convexity of the yield curve

Sector spreads

Corporate spreads

Fixed Income

Portfolio

Management …

Strategies

Portfolio Construction

Fixed Income : Valuation and Analysis-

211

Fixed Income Portfolio Management

Strategies

Active Management in practice

Constant duration

Fundamentals

Mean reversion process

Time Value of decline

Money

Match duration of the index until upper trigger limit,

then back to average level of the index duration

Portfolio

Management rates

Strategies

Risk : Change in medium term inflation rate =>

adjust the model

Fixed Income : Valuation and Analysis-

212

Fixed Income Portfolio Management

Strategies

Active Management in practice

Return enhancement

Fundamentals

Use of a valuation model

Time Value of

Money Arbitrage type

Options overwriting

Fixed Income

Portfolio Forecast is on the timing of long term interest

Management rates

Strategies

213

Fixed Income Portfolio Management

Strategies

Active Management in practice

Return enhancement

Fundamentals

Minimisation of the value of the bond portfolio

Time Value of

Money

Two constraints :

Fixed Income

Portfolio

Management

Strategies

present value of the liability

Fixed Income : Valuation and Analysis-

214

Fixed Income Portfolio Management

Strategies

Active Management in practice

Return enhancement

Fundamentals

Time Value of

Money

Homogeneous in terms of quality rating

Fixed Income

Portfolio

Management

Strategies

215

Fixed Income Portfolio Management

Strategies

Active Management

Fundamentals

Type of issuer

Credit risk

Time Value of

Money

Coupon level

Maturity

Fixed Income

Portfolio

Management

Strategies

216

Fixed Income Portfolio Management

Strategies

Active Management

Fundamentals

Positioning of the portfolio components to gain from

movements in yield spreads

Money

undervalued one

Fixed Income

Portfolio Tend to widen when recession

Management

Strategies If economic activity is approaching the peak :

flight to quality

217

Fixed Income Portfolio Management

Strategies

Active Management

Fundamentals

Call provision

Time Value of

Money Volatility

non callable

Fixed Income

Portfolio

Management

Strategies Forecasting term structure of interest rates

on these assumptions

Fixed Income : Valuation and Analysis-

218

Fixed Income Portfolio Management

Strategies

Active Management

Fundamentals

Take advantage of the forecasted movements

Time Value of

Money

Yield curve changes : maturity can have a significant

impact on total return of the portfolio

Fixed Income

Portfolio

strategies

Management

Strategies Bullet : concentrated on a given point of the yield

curve

Fixed Income : Valuation and Analysis-

219

Fixed Income Portfolio Management

Strategies

Active Management

Laddering

Money

Passive portfolio approach

Fixed Income

Portfolio Reinvestment risk minimized

Management

Strategies

220

Fixed Income Portfolio Management

Strategies

Active Management

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

221

Fixed Income Portfolio Management

Strategies

Passive Management

Fundamentals

Indexation

Time Value of

Money Differences with equity indexing :

Fixed Income

Portfolio

Management Illiquidity

Strategies

Bond futures : rarely on indices but on notional bonds

222

Fixed Income Portfolio Management

Strategies

Passive Management

Indexation

Fundamentals

Money

specific than equities

Fixed Income

Portfolio

Management

Strategies

223

Fixed Income Portfolio Management

Strategies

Passive Management

Indexing technology

Fundamentals

Stratified sampling

Time Value of

Money

Avoid trading too small bond positions

Fixed Income

Portfolio

Management

Strategies

224

Fixed Income Portfolio Management

Strategies

Passive Management

Indexing technology

Fundamentals

Stratified sampling

Time Value of

Money

Benchmark partitioned into cells based

on characteristics (sector, maturity,

duration, quality)

Fixed Income

Portfolio Select a limited number of bonds in

Management each cells

Strategies

weight

Fixed Income : Valuation and Analysis-

225

Fixed Income Portfolio Management

Strategies

Passive Management

Indexing technology

Fundamentals

Optimised sampling

Time Value of

Money

sampling approach

error

Fixed Income

Portfolio Optimiser : risk trade-off between

Management

Strategies factors and transaction costs

Fixed Income : Valuation and Analysis-

226

Fixed Income Portfolio Management

Strategies

Passive Management

Immunisation

Money

Balance price risk and reinvestment risk

Fixed Income

Portfolio

Management

Strategies

227

Fixed Income Portfolio Management

Strategies

Passive Management

Immunisation

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

228

Fixed Income Portfolio Management

Strategies

Passive Management

Immunisation

Fundamentals

Short time horizon : effect on the bond price is higher

Time Value of is higher

Money

Time-horizon for which the final wealth will be the

same, whatever initial interest rate variation

Fixed Income If time horizon = duration : investor not affected by

Portfolio

Management interest rates variations

Strategies

Create portfolio with duration = time horizon of the

investor

229

Fixed Income Portfolio Management

Strategies

Passive Management

Immunisation

Fundamentals

Portfolio has to be rebalanced whenever a coupon

payment comes due

Money interest rates

equilibrium

Fixed Income

Portfolio

Management

=> Immunization has to be dynamic (rebalance

Strategies

frequently)

230

Fixed Income Portfolio Management

Strategies

Passive Management

Immunisation

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

231

Fixed Income Portfolio Management

Strategies

Passive Management

Fundamentals

Immunisation

minimizing the transaction costs

Time Value of

Money Protects against loss but eliminates benefits

from interest rate variation

Fixed Income

Based on duration : assumes parallel shift of the

Portfolio flat interest rate term structure

Management

Strategies

Time-passing and yield changing : portfolio

non-immunized

232

Fixed Income Portfolio Management

Strategies

Passive Management

Liability Funding

Fundamentals

Money

Compensate the interest rate risk on the liability

side

Fixed Income

Portfolio

Management

Strategies

233

Fixed Income Portfolio Management

Strategies

Passive Management

Liability Funding

Fundamentals

Immunisation

Time Value of

Fund a liability stream and control for

Money parallel shifts in the yield curve

Fixed Income

A = Present value of the cash-flow stream

Portfolio

Management from the bond portfolio

Strategies

234

Fixed Income Portfolio Management

Strategies

Passive Management

Liability Funding

Fundamentals

Single period immunisation

Time Value of parallel shift of the interest rate term structure

Money

Solution : buy zero coupon bonds

Fixed Income of ordinary bonds

Portfolio

Management

Strategies

235

Fixed Income Portfolio Management

Strategies

Passive Management

Liability Funding

Fundamentals

Time Value of

the same rate (IRR)

Money

Duration of bond portfolio and liability are equal (single

period : duration = maturity)

Portfolio

Management Convexity

Strategies

Infinite number of portfolios with duration = T, choose

the bond with cash-flow around the liability maturity =>

less sensitive to non-parallel shifts

Fixed Income : Valuation and Analysis-

236

Fixed Income Portfolio Management

Strategies

Passive Management

Liability Funding

Fundamentals

Time Value of

Money duration :

Fixed Income

Portfolio

Management

Strategies The smaller the dispersion, the smaller the risk

Fixed Income : Valuation and Analysis-

237

Fixed Income Portfolio Management

Strategies

Passive Management

Liability Funding

Fundamentals

Multiperiod immunisation

Time Value of

Money

Technique for a single liability to each of the

several liabilities

Fixed Income

Portfolio

Management

Strategies

Risk of discontinuities if large liability matures at

a specific time (dynamic readjustment of the bond

portfolio duration)

Fixed Income : Valuation and Analysis-

238

Fixed Income Portfolio Management

Strategies

Passive Management

Liability Funding

Fundamentals

Surplus immunisation

Money value of his liabilities

S=A–L

Fixed Income

Portfolio To immunise :

Management

Strategies Positive surplus : Duration of A should be

smaller

239

Fixed Income Portfolio Management

Strategies

Passive Management

Time Value of

Money Create a bond portfolio whose stream of

cash flows exactly matches stream of

liabilities

Portfolio

Management

Strategies

240

Fixed Income Portfolio Management

Strategies

Passive Management

Liability Funding

Fundamentals

Cash flow matching

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

241

Fixed Income Portfolio Management

Strategies

Passive Management

Liability Funding

Fundamentals

Time Value of

Money flow matching

Drawbacks :

Fixed Income

Difficulties of perfect date matching

Portfolio

Management Difficult exact amount matching (rounding in

Strategies the bond quantities)

242

Fixed Income Portfolio Management

Strategies

Passive Management

Liability Funding

Fundamentals

Asymmetric cash matching

BEFORE

Time Value of

Money

Build a non-callable bond portfolio of

homogeneous characteristics

Fixed Income

Portfolio cash flow of the liabilities (any liabilities is funded)

Management

Strategies Amount and maturity of cash flows should match

as far as possible (limit term structure risk factor)

243

Fixed Income Portfolio Management

Strategies

Passive Management

Liability Funding

Fundamentals

Asymmetric cash matching

Time Value of cheapest portfolio is also the best cash flow match

Money

Only with bonds of the same quality

Fixed Income

Portfolio Reinvestment based on an assumption for cash rate

Management

Strategies ⇒ Reinvestment risk if cash is actually smaller

to build an even cheaper bond portfolio

Fixed Income : Valuation and Analysis-

244

Fixed Income Portfolio Management

Strategies

Passive Management

Liability Funding

Fundamentals

Time Value of

Money bond cash flow can occur AFTER

maturity of liabilities

Fixed Income

Portfolio

Management Can be cheaper depending on the borrowing

Strategies costs

245

Fixed Income Portfolio Management

Strategies

Portfolio construction based on a factor model

Volatility of the term structure => MFM for better risk control

Fundamentals

Model specification

Time Value of

Money

Portfolio

Management Ignore the interest accrual

Strategies

Assume that duration is constant through time

246

Fixed Income Portfolio Management

Strategies

Fundamentals

Single factor duration model

current yield

Time Value of Duration = factor exposure of the bond

Money

Assumptions :

Fixed Income

Portfolio Only small parallel shifts

Management

Strategies Explains 75% of the variance of non-callable US Treasury

bond return

Fixed Income : Valuation and Analysis-

247

Fixed Income Portfolio Management

Strategies

Portfolio construction based on a factor model

Fundamentals

Time Value of

Money the discount bonds

Fixed Income

Portfolio Z = exposure of a bond to all discount bonds

Management W = covariance matrix for the return of the set of discount

Strategies bonds

⇒ Not convenient for complicated movements in the curve

Fixed Income : Valuation and Analysis-

248

Fixed Income Portfolio Management

Strategies

Portfolio construction based on a factor model

Fundamentals

term structure

Money

Return of the shift factor

Return of the twist factor

Return of the butterfly factor

Fixed Income

Portfolio

Management

Strategies

249

Fixed Income Portfolio Management

Strategies

Portfolio construction based on a factor model

return on discount bonds => discount yields declined)

Time Value of negative on long term (steeper curve, positive twist)

Money

If RB > 0 : Positive return on both end of maturities.

Negative on intermediate (more concave curve)

Fixed Income

Portfolio

Management

Strategies

butterfly returns

Fixed Income : Valuation and Analysis-

250

Fixed Income Portfolio Management

Strategies

Portfolio construction based on a factor model

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management There are other risks than movements in the term structure

Strategies

Existence of options, sinking fund provisions

Default risk

Tax

Fixed Income : Valuation and Analysis-

251

Fixed Income Portfolio Management

Strategies

Portfolio construction based on a factor model

Fundamentals

a bond is relatively small

Time Value of

Money Bonds are more interchangeable

Fixed Income

Portfolio

Management

Strategies

252

Fixed Income Portfolio Management

Strategies

Portfolio construction based on a factor model

Fundamentals

Interest rate anticipation strategies

forecast of the movements of the yield curve

Time Value of

Money

Build a portfolio with risk exposure consistant

with his prediction of the term structure

movements

Fixed Income

Portfolio

Management

Strategies

253

Fixed Income Portfolio Management

Strategies

=> More exposed to the shift factor than the

Time Value of benchmark

Money

Forecast steeper term structure :

=> Exposure to the twist factor higher than the

benchmark

Fixed Income

Portfolio

Forecast more concave term structure :

Management

Strategies => Exposure to the butterfly factor higher than

the benchmark

Fixed Income : Valuation and Analysis-

254

Fixed Income Portfolio Management

Strategies

Money

scenario

Risk model

Fixed Income

Portfolio Optimiser to minimise tracking error with

Management constrains on risk exposures

Strategies

risk adjusted active return of the bond portfolio

Fixed Income : Valuation and Analysis-

255

Fixed Income Portfolio Management

Strategies

Computing the hedge ratio : the modified duration method

Fundamentals

Optimal hedge ratio :

Time Value of

Money

Portfolio

Management

Strategies Omits convexity (convexity between CTD and asset being

hedged)

Fixed Income : Valuation and Analysis-

256

Fixed Income Portfolio Management

Strategies

Computing the hedge ratio : the modified duration method

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

Short hedge : Sell interest rate futures to « freeze » low

interest rates today

Fixed Income : Valuation and Analysis-

257

Fixed Income Portfolio Management

Strategies

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

258

Fixed Income Portfolio Management

Strategies

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

259

Fixed Income Portfolio Management

Strategies

EVALUATION AND RISK

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

260

Fixed Income Portfolio Management

Strategies

EVALUATION AND RISK

Fundamentals

Time Value of

Money

Fixed Income

Portfolio

Management

Strategies

261

Fixed Income Portfolio Management

Strategies

Fundamentals

Time Value of

Money

Fixed Income

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