Fixed Income Markets Management, Trading and Hedging

Fully updated with comprehensive coverage of the post-crisis debt markets and their impact on key industry issues, Fixed Income Markets: Management, Trading, and Hedging, Second Edition offers insights into derivative pricing, cross-currency hedging, and new liquidity legislation. Written by Choudhry, Moskovic, and Wong, Fixed Income Markets is an indispensable read for anyone working in bond markets, interest-rate markets, and credit derivatives markets looking to better understand today's debt markets.

This acclaimed book takes a unique look into the leading practices in bond markets as well as post-credit-crunch impacts on pricing that are rarely captured in textbooks. The new edition provides expanded coverage on a wide range of topics within hedging, derivatives, bonds, rebalancing, and global debt capital markets. New topics include:

• Dynamic hedging practices and cross-currency hedging
• Collateralized and uncollateralized derivatives, and their impact on valuation
• Callable bonds, pricing, trading, and regulatory aspects related to liquidity
• Rebalancing as a method for capturing contingencies and other complex imbedded risks

As a bonus, the book includes reference information for statistical concepts and fixed income pricing, as well as a full glossary and index. Written in Choudhry's usual accessible style, Fixed Income Markets is a comprehensive and in-depth account of the global debt capital markets in today's post-crisis world.

MOORAD CHOUDHRY works in Group Treasury at The Royal Bank of Scotland, and is a Professor at the Department of Mathematical Sciences, Brunel University. He was a UK government bond trader and money markets trader with ABN Amro Hoare Govett Securities Ltd and a sterling proprietary trader with Hambros Bank Limited. He later traded structured finance bonds and repo at KBC Financial Products. Moorad lives in Surrey, England.

DAVID MOSKOVIC is a hybrid derivatives trader at The Royal Bank of Scotland. Prior to that he worked in market risk and as a quantitative analyst. He qualified as a Chartered Accountant at Ernst & Young before moving to RBS.

MAX WONG is Head of Risk Model Validation at The Royal Bank of Scotland in Singapore. He was previously an index futures trader on the open-outcry floor at SIMEX and a risk quant at Standard Chartered. He is author of Bubble Value at Risk: A Countercyclical Risk Management Approach.

Preface xvii

About the Authors xix

PART ONE Introduction to Bonds 1

CHAPTER 1 The Bond Instrument 3

CHAPTER 2 Bond Instruments and Interest-Rate Risk 43

Appendix 2.1 Formal Derivation of Modifi ed-Duration Measure 59

Appendix 2.2 Measuring Convexity 59

Appendix 2.3 Taylor Expansion of the Price/Yield Function 61

CHAPTER 3 Bond Pricing, Spot, and Forward Rates 65

Appendix 3.1 The Integral 83

Appendix 3.2 The Derivation of the Bond Price Equation in Continuous Time 85

CHAPTER 4 Interest-Rate Modelling 89

Appendix 4.1 Geometric Brownian Motion 101

CHAPTER 5 Fitting the Yield Curve 105

Appendix 5.1 Linear Regression: Ordinary Least Squares 124

Appendix 5.2 Regression Splines 127

PART TWO Selected Market Instruments 133

CHAPTER 6 The Money Markets 135

Appendix 6.1 179

CHAPTER 7 Hybrid Securities and Structured Securities 181

CHAPTER 8 Bonds with Embedded Options and Option-Adjusted Spread Analysis 205

Appendix 8.1 Calculating Interest Rate Paths Using Microsoft Excel 232

CHAPTER 9 Infl ation-Indexed Bonds and Derivatives 235

Appendix 9.1 Current Issuers of Public-Sector Indexed Securities 256

Appendix 9.2 U.S. Treasury Infl ation-Indexed Securities (TIPS) 257

CHAPTER 10 Introduction to Securitisation and Asset-Backed Securities 261

PART THREE Derivative Instruments 297

CHAPTER 11 Forwards and Futures Valuation 299

CHAPTER 12 Bond Futures Contracts 309

Appendix 12.1 The Conversion Factor for the Long Gilt Future 324

CHAPTER 13 Swaps 329

Appendix 13.1 Calculating Futures Strip Rates and Implied Swap Rates 370

CHAPTER 14 Credit Derivatives I: Instruments and Applications 375

Appendix 14.1 Bond Credit Ratings 418

CHAPTER 15 Credit Derivatives II: Pricing, Valuation, and the Basis 421

CHAPTER 16 Options I 435

Appendix 16.1 Summary of Basic Statistical Concepts 456

Appendix 16.2 Lognormal Distribution of Returns 457

Appendix 16.3 Black-Scholes Model in Microsoft Excel 458

CHAPTER 17 Options II 461

PART FOUR Bond Trading and Hedging 475

CHAPTER 18 Value-at-Risk and Credit VaR 477

Appendix 18.1 Assumption of Normality 513

CHAPTER 19 Government Bond Analysis, the Yield Curve, and Relative-Value Trading 517

CHAPTER 20 Approaches to Trading and Hedging 551

Appendix 20.1 Summary of Derivation of Optimum Hedge Equation 571

Appendix 20.2 Forward-Rate Structure in Conventional Yield-Curve Environment 571

CHAPTER 21 Derivatives Risk Management: Convexity, Collateral, and Correlation 573

APPENDIX A Statistical Concepts 621

APPENDIX B Basic Tools 627

APPENDIX C Introduction to the Mathematics of Fixed-Income Pricing 633

APPENDIX D About the Companion Website 639

Glossary 641

Index 669

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