Bond Evaluation, Selection, and Management, Second Edition + Website

Preface xvii Acknowledgments xxi PART ONE Bond Evaluation 1 CHAPTER 1 Overview of the Financial System 3 1.1 Real and Financial Assets 3 1.2 Types of Debt Claims 4 1.3 Financial Market 6 1.4 Types of Financial Markets 7 1.5 Regulations 15 1.6 Efficient Financial Markets 17 1.7 Characteristics of Assets 20 1.8 Conclusion 23 CHAPTER 2 Bond Value and Return 29 2.1 Introduction 29 2.2 Bond Valuation 29 2.3 The Yield to Maturity and Other Rates of Return Measures 43 2.4 Rates on Zero-Coupon Bonds 49 2.5 Total Return 51 2.6 Spot Rates and Equilibrium Prices 57 2.7 Geometric Mean 60 2.8 Conclusion 64 CHAPTER 3 The Level and Structure of Interest Rates 75 3.1 Introduction 75 3.2 Level of Interest Rates 77 3.3 The Structure of Interest Rates 91 3.4 Conclusion 99 CHAPTER 4 The Term Structure of Interest Rates 105 4.1 Introduction 105 4.2 Market Segmentation Theory 107 4.3 Preferred Habitat Theory 118 4.4 Pure Expectations Theory 120 4.5 Liquidity Premium Theory 132 4.6 Summary of Term Structure Theories 132 4.7 Constructing the Benchmark Yield Curve 133 4.8 Conclusion 138 CHAPTER 5 Bond Risk 147 5.1 Introduction 147 5.2 Default Risk 147 5.3 Call Risk 159 5.4 Market Risk 162 5.5 Duration and Convexity 169 5.6 Conclusion 182 PART TWO Debt Markets 191 CHAPTER 6 Corporate Debt Securities 193 6.1 Introduction 193 6.2 Corporate Bonds 194 6.3 Bankruptcy 207 6.4 The Markets for Corporate Bonds 209 6.5 Medium-Term Notes 214 6.6 Commercial Paper 215 6.7 Conclusion 217 CHAPTER 7 Treasury and Agency Securities 225 7.1 Introduction 225 7.2 Treasury Instruments 225 7.3 Repurchase Agreements 240 7.4 Federal Agency Securities 243 7.5 Conclusion 252 CHAPTER 8 Municipal Securities 259 8.1 Introduction 259 8.2 Municipal Financing 259 8.3 Tax-Exempt Status 260 8.4 Types of Municipals 261 8.5 Special Features of Municipals 266 8.6 Credit Risk, Quality Ratings, and Credit Spreads 267 8.7 Municipal Bond Markets 274 8.8 Conclusion 276 CHAPTER 9 Intermediary Debt Securities 283 9.1 Introduction 283 9.2 Bank Securities 283 9.3 Banker's Acceptances 287 9.4 Mortgage-Backed and Asset-Backed Securities 288 9.5 Investment Funds 289 9.6 Insurance Companies and Pension Funds 303 9.7 Conclusion 309 CHAPTER 10 International Debt Securities 317 10.1 Introduction 317 10.2 International Debt Securities 317 10.3 The Foreign Bond Market 318 10.4 The Eurobond Market 318 10.5 Non-U.S. Domestic Bonds 321 10.6 Emerging Market Debt 323 10.7 Global Fixed-Income Mutual Funds and ETFs 324 10.8 Foreign Bond Risk and Sovereign Bond Ratings 324 10.9 Eurocurrency Market 326 10.10 The Foreign Currency Market and Exchange-Rate Risk 333 10.11 Conclusion 336 CHAPTER 11 Residential Mortgages and Mortgage-Backed Securities 343 11.1 Introduction 343 11.2 Residential Mortgage Loans 344 11.3 Mortgage Portfolio 351 11.4 Mortgage-Backed Securities 360 11.5 Features of Mortgage-Backed Securities 361 11.6 Collateralized Mortgage Obligations and Strips 365 11.7 Evaluating Mortgage-Backed Securities 376 11.8 Conclusion 377 CHAPTER 12 Nonagency Residential MBSs, Commercial MBSs, and Other Asset-Backed Securities 391 12.1 Introduction 391 12.2 Nonagency Mortgage-Backed Securities 391 12.3 Commercial Mortgage-Backed Securities 394 12.4 Asset-Backed Securities 396 12.5 Collateralized Debt Obligations 400 12.6 Conclusion 404 PART THREE Bond Strategies and the Evaluation of Bonds with Embedded Options 411 CHAPTER 13 Bond Investment Strategies 413 13.1 Introduction 413 13.2 Active Investment Strategies 414 13.3 Passive Bond Management Strategies 423 13.4 Bond Immunization Strategies 428 13.5 Conclusion 437 CHAPTER 14 Binomial Interest Rate Trees and the Valuation of Bonds with Embedded Options 451 14.1 Introduction 451 14.2 Binomial Interest Rate Model 452 14.3 Valuing Bonds with Other Option Features 461 14.4 Convertible Bond 466 14.5 Valuing Mortgage-Backed Securities 473 14.6 Conclusion 480 CHAPTER 15 Estimating the Binomial Tree 487 15.1 Introduction 487 15.2 Subdividing the Binomial Tree 487 15.3 Estimating the Binomial Tree 488 15.4 u and d Estimation Approach 492 15.5 Calibration Model 496 15.6 Option-Adjusted Spread 503 15.7 Duration and Convexity 505 15.8 A Note on the Black-Scholes Option Pricing Model 506 15.9 Conclusion 508 PART FOUR Debt Derivatives: Futures and Options 515 CHAPTER 16 Futures Contracts on Debt Securities: Fundamentals 517 16.1 Introduction 517 16.2 The Market and Characteristics of Futures on Debt Securities 520 16.3 The Nature of Futures Trading and the Role of the Clearinghouse and Margins 526 16.4 Futures Hedging 531 16.5 Futures Pricing 536 16.6 Conclusion 541 CHAPTER 17 Interest Rate Options Contracts: Fundamentals 549 17.1 Introduction 549 17.2 Options Terminology 550 17.3 Markets and Types of Interest Rate Options 552 17.4 Option Positions 556 17.5 Options Trading-Microstructure 566 17.6 Option Price Relationships 571 17.7 Conclusion 576 CHAPTER 18 Managing Fixed-Income Positions with Interest Rate Derivatives 583 18.1 Introduction 583 18.2 Hedging Fixed-Income Positions 583 18.3 Cross Hedging 590 18.4 Speculating with Interest Rate Derivatives 593 18.5 Synthetic Debt and Investment Positions 596 18.6 Using Options to Set a Cap or Floor on a Cash Flow 599 18.7 Conclusion 599 CHAPTER 19 Managing Fixed-Income Positions with OTC Derivatives 607 19.1 Introduction 607 19.2 Hedging with OTC Derivatives 607 19.3 Hedging a Series of Cash Flows: OTC Caps and Floors 612 19.4 Financing Caps and Floors: Collars and Corridors 615 19.5 Other Interest Rate Products 620 19.6 Hedging Currency Positions with Foreign Currency Options 624 19.7 Conclusion 627 PART FIVE Swaps 635 CHAPTER 20 Interest Rate Swaps 637 20.1 Introduction 637 20.2 Generic Interest Rate Swaps 637 20.3 Swap Market 644 20.4 Swap Valuation 648 20.5 Comparative Advantage and the Hidden Option 650 20.6 Swaps Applications 653 20.7 Credit Risk 657 20.8 Conclusion 658 CHAPTER 21 Swap Derivatives: Forward Swaps and Swaptions 667 21.1 Introduction 667 21.2 Forward Swaps 667 21.3 Swaptions 670 21.4 Cancelable and Extendable Swaps 677 21.5 Nongeneric Swaps 678 21.6 Conclusion 678 CHAPTER 22 Currency and Credit Default Swaps 685 22.1 Introduction 685 22.2 Currency Swaps 685 22.3 Credit Default Swaps 691 22.4 Conclusion 705 Key Terms 705 APPENDIX A Uses of Exponents and Logarithms 713 APPENDIX B Mathematical Statistical Concepts 719 APPENDIX C Primer on Return, Present Value, and Future Value 727 APPENDIX D Web Site Information and Examples 737 APPENDIX E Global Investments and Exchange Rates 745 APPENDIX F Arbitrage Features of the Calibration Model 747 APPENDIX G T-Bond Delivery Procedure and Equilibrium Pricing 749 APPENDIX H Pricing Interest Rate Options with a Binomial Interest Tree 753 APPENDIX I Pricing Interest Rate Options with the Black Futures Option Model 763 What's on the Companion Web Site 769 Answers and Solutions to Select End-of-Chapter Problems 771 Glossary of Terms 831 Index 855