Lecture Notes In Fixed Income Fundamentals

by Eliezer Z Prisman

Overview

Written for undergraduates, this book is dedicated to fixed income fundamentals that do not require modeling the dynamics of interest rates. The book concentrates on understanding and explaining the pillars of fixed income markets, using the modern finance approach implied by the 'no free lunch' condition. It focuses on conceptual understanding so that novice readers will be familiar with tools needed to analyze bond markets. Institutional information is covered only to the extent that is necessary to obtain full appreciation of concepts.This volume will equip readers with a solid and intuitive understanding of the No Arbitrage Condition — its link to the existence and estimation of the term structure of interest rates, and to valuation of financial contracts. Using the modern approach of arbitrage arguments, the book addresses positions and contracts that do not require modeling evolution of interest rates. As such, it welcomes readers lacking the technical background for this modeling, and provides them with good intuition for interest rates, no arbitrage condition, bond markets and certain financial contracts.

Product Details

ISBN-13:	9789813149762
Publisher:	World Scientific Publishing Company, Incorporated
Publication date:	04/19/2017
Series:	World Scientific Lecture Notes In Finance , #2
Pages:	268
Product dimensions:	5.90(w) x 9.00(h) x 0.50(d)

Table of Contents

Preface v

About the Author xv

1 Introduction and Review of Simple Concepts 1

1.1 Annuities, perpetuities and mortgages 8

1.2 Forward Contracts 11

1.3 Swaps 15

1.4 Conclusions 16

1.5 Questions and problems 16

2 A Basic Model of Bond Markets 19

2.1 Setting the Framework 19

2.2 Arbitrage in the Debt Market 23

2.3 Defining the No-Arbitrage Condition 37

2.4 Pricing by Replication and Discount Factors 45

2.5 Discount Factors and NA 52

2.6 Rates, Discount Factors, and Continuous Compounding 57

2.6.1 Continuous Compounding 57

2.7 Concluding Remarks 58

2.8 Questions and Problems 58

2.9 Appendix 62

2.9.1 No-Arbitrage Condition in the Bond Market 62

2.9.2 Geometric interpretation of the NA 63

2.9.3 Continues compounding and ordinary differential equations 66

3 The Term Structure, its Estimation, and Smoothing 69

3.1 The Term Structure of Interest Rates 69

3.1.1 Zero-Coupon, Spot, and Yield Curves 73

3.2 Smoothing of the Term Structure 81

3.2.1 Smoothing and Continuous Compounding 92

3.3 Forward Rate 94

3.3.1 Forward Rate: A Classical Approach 94

3.3.2 Forward Rate: A Practical Approach 98

3.4 A Variable Rate Bond 102

3.5 Concluding Remarks 106

3.6 Questions and Problems 107

3.7 Appendix 113

3.7.1 Theories of the Shape of the Term Structure 113

3.7.2 Approximating Functions 117

4 Duration and Immunization 119

4.1 Duration: a sensitivity measure of bonds' prices to changes in interest rates 119

4.2 Immunization, A First look 137

4.3 Generalized duration and Immunization 142

4.4 Immunization strategies with and without short sales 150

4.5 Concluding Remarks 163

4.6 Questions and Problems 164

5 Forwards, Eurodollars, and Futures 171

5.1 Forward Contracts: A Second Look 171

5.2 Valuation of Forward Contracts Prior to Maturity 174

5.3 Forward Price of Assets That Pay Known Cash Flows 180

5.3.1 Forward Contracts, Prior to Maturity, of Assets That Pay Known Cash Flows 185

5.3.2 Forward Price of a Stock That Pays a Known Dividend Yield 188

5.4 Eurodollar Contracts 190

5.4.1 Forward Rate Agreements 190

5.5 Futures Contracts: A Second Look 194

5.6 Deterministic Term Structure (DTS) 198

5.7 Futures Contracts in a DTS Environment 201

5.8 Concluding Remarks 211

5.9 Questions and Problems 212

6 Swaps: A Second Look 217

6.1 A Fixed-for-Float Swap 217

6.1.1 Valuing an Existing Swap 223

6.2 Currency Swaps 226

6.3 Commodity and Equity Swaps 237

6.3.1 Equity Swaps 241

6.4 Forwards and Swaps: A Visualization 245

6.5 Concluding Remarks 247

6.6 Questions and Problems 248

Index 251